Consequences of Not Thinking Things Through

Sometimes we believe that we are backing a worthy cause or making a good decision, but it turns out (sometimes too late) not to be the case.  Two recent examples in the news are trophy hunting and tax deductibility.  Though they may seem totally unrelated, they share the common characteristic that we tend not to think them through.

They both tend to be political, which makes it all the more important that we fully understand what is going on so as not to be manipulated by the opposing forces.  In these cases I am taking a critical thinking approach rather than taking sides.

In the first case, many oppose trophy hunting as treating animals badly.  There was talk earlier this year of banning imports of trophy-hunted elephants and possibly other species for that reason.  A deeper look reveals a different story.

This article from CNN explains that the major threat facing elephants and other exotic wildlife is not the trophy hunters, but other factors such as loss of habitat, retaliatory killing by local farmers and poaching.  Poachers come at night to kill the elephants for their ivory.  Controlling poaching, reimbursing farmers for crop damage and preserving the savannah requires funding.  A major source of that funding is the license fees paid by the rich trophy hunters.  As long as the hunting is well regulated, the overall impact on wildlife can be positive.

It seems counterintuitive at first glance that shooting a few elephants or lions in a well-regulated way could benefit the larger group, but it’s true.  The writer of the CNN piece admits to being a conservationist and vegetarian who wishes for a different solution, but the revenue ensures positive outcomes for animals as a whole and jobs for local game wardens.  Other sources agree, including The University of Washington’s Conservation Magazine and the National Geographic.  Yet some want to brand these fat-cat hunters as evil men who hate animals and are destroying the planet.

The second example has to do with tax deductibility, which is the subject of a fuss in Washington over a new tax law.  Various proposals intend to double the standard deduction while eliminating different itemized deductions.  But are these deductions as valuable as their backers claim?  Here is a simplified explanation.

A deduction is the amount we subtract from our income before calculating taxes.  If we earn $50,000 and have $15,000 in deductions, we pay tax on only $35,000.  Using a 15% tax bracket, the actual savings is not $15,000, but 15% of that, or $2,250 – still nothing to sneeze at.

But don’t forget the standard deduction!  You must spend that $15,000 to get the benefit, but we can subtract $12,000 without doing anything, which would reduce our taxes by $1,800 (15% of 12,000).  In this example, the difference between having the deduction and not is only $450, or 3% of the total deduction.

Now I don’t know many people who would go rushing to the store for a 3%-Off sale, but that’s not the way it’s presented.  When the state or local government wants to raise your taxes they explain how it won’t hurt you because “it’s all tax-deductible.”  When a charity wants your money they emphasize the tax-deductibility.  When a tax preparer charges $50 for software or over $100 for the personal touch, they don’t tell you that this money saved you only an incremental $450.  No, they stress the much larger number at the bottom of your return, remind you that their fee is also tax-deductible and then urge you to get your money today at their high interest rate.  (Note:  The CPA Practice Advisor says that you should expect to pay an average of $273 in the 2017 filing season if you want to itemize your deductions.)

Elected officials at all levels, charities, environmentalists, tax preparers, animal rights advocates, realtors and many others depend on the majority of us not to think too deeply.  Perhaps some of them aren’t thinking clearly themselves.  But when we just nod in blind agreement, allowing ourselves to be misled, we get poor outcomes and may never realize it.

The American Dream Scam

I was shocked and surprised when I came across this article.  The title, “9 things that rule about owning a home” got my attention right away.  As I read through the nine categories I found what I expected to find, traditional and promotional information about home ownership that is either partially or mostly incorrect.  Here they are.

1.     Your money's going to you, not to a landlord.  It goes on to explain that with renting “you're just renting space,” but “money that you put into your home builds equity, the value of your home after the mortgage is subtracted. Loans taken out against your home's equity can be used to put money towards other things, such as college education.”  In reality, especially with the popularity of very low down payment mortgages, most of your payments for the initial years go to interest.  True, you are not renting space; instead you are renting money.  Before the turn of the century, the value of houses increased at approximately the rate of inflation.  You didn’t sell a house at a profit unless you intended to buy a smaller house.  About twenty years ago this changed, but we learned (or at least some of us learned) from the recession resulting from the overdue correction that the surge in housing values was mostly artificial.  Finally, the rate for home equity loans is lower, but that’s because you are risking your house, using it as collateral and exposing yourself and your family to foreclosure if it’s not paid back.

2.     You get tax benefits.  As I explained in detail two weeks ago, the tax deduction is partial at best.  About two in three do not itemize deductions so it does them no good at all.  Those who do benefit only to the extent that their total deductions exceed the standard deduction, which is automatic.  In nearly every case the tax benefits of paying a mortgage are either non-existent or exaggerated.

3.       It's forced savings.  The argument is that “those payments are coming back to you in the form of home equity, which increases your net worth.”  It may increase your wealth on paper, but if you sell the house that equity is swallowed up on a down payment for the next one.  Eventually you will have an asset that is all yours, but it’s not a very liquid asset because you still need some place to live.

4.     You get more for your money.  Sometimes this is true and sometimes it’s not.  The balance between buying and renting fluctuates based on supply and demand in the respective markets.

5.     You have the freedom to make it home.  The argument here is that you don’t need a landlord’s permission to make changes.  You can fix up everything the way you want it.  But you also need to fix everything that goes wrong and pay for it yourself.  I’ve heard it said (and experienced it myself) that when you buy a house you get a hobby:  repairing, replacing and maintaining or researching for a reliable person to do it for you.

6.     You can have pets.  Some rentals also allow pets.

7.     You'll love the stability.  Stability is one side of the coin.  The other is finding that you must move and are stuck with two mortgages until you find a buyer for the first house.

8.     You know everything about the place, because the bank required an inspection, which you paid for, before you moved in.

9.     It’s yours!  "You feel empowered that you actually own something…like you have a piece of the American dream."  Wow, if they can’t get you with the first eight, why not appeal to your ego?

Those are nine very weak reasons to buy a house, every one of them partially or mostly untrue.  I don’t think I am being unusually fussy when I point out that many of these fall under the category of what “Robert J. Samuelson termed a ‘psycho-fact,’ [a] belief that, though not supported by hard evidence, is taken as real because its constant repetition changes the way we experience life.”  As many people found out over the past 10 years, buying a house is not something to be taken lightly or to be done without reading the fine print and fully understanding the situation.

Is It Really Tax Deductible?

As we near tax day it makes sense to review a matter most people either don’t understand or don’t really think about – the issue of tax deductibility, what it really means and how people use it to sell goods, ideas and charitable causes.

Many years ago the interest you paid was all tax deductible, whether it was for credit cards or a car loan or whatever.  This changed in 1986 ending deductibility for all interest except home loans.  No doubt that the realtors and builders had some influence in the exemption of mortgage interest so they could continue to sell the advantages of deductibility. 

What happened next?  The banks began heavily marketing home equity loans.  Buy your car but use your house as collateral and still deduct the interest.  (This is another example of how we must look after ourselves rather than relying on consumer protection agencies, because when it comes to finances, bankers are a lot smarter than politicians and will come up with new products to take advantage of any rule changes.)

When we hear this promise of tax deductibility from anyone, what does it really mean and how much of an advantage is it?  Since fewer than one in seven people even look at a tax form anymore (see graph), preferring to hand the box of receipts off to someone else or to wade through the hundreds of questions delivered by tax preparation software that mysteriously translates all the answers into the lines on a 1040 form, I think most don’t have a clue about the mild deceit going on here.  Not everything that is legally tax-deductible and listed on your return provides any benefit at all.

Here’s how it works.  Everyone can choose either itemizing those deductions or claiming an automatic standard deduction.  Based on data from last year only about 31% chose to list all their deductions.  The rest took the standard deduction.  Deductions that may be itemized include mortgage interest, property taxes, certain other taxes, contributions to eligible charities, medical expenses (but only for the amount above 7.5% of your income) and certain other unreimbursed employee expenses, such as job travel, union dues, job education, etc.

The standard deduction, the one you could get no matter what is $6300 for a single person and $12,600 for a married couple.  So the value of the first $12,600 of deductions for a married couple (filing jointly) is exactly zero!  You could get it any way regardless of your other decisions!  Suppose you have no major health expenses, mortgage interest of $6,000, property tax of $3000, state income tax of $2500 and donations of $1500; the total is only $400 above the standard deduction.  If you are in the 25% tax bracket, your taxes are lowered by $100.  On one hand, it’s nice to get an extra $100 back from the government.  On the other hand, is that what you expected when the realtor sold you the house with the promise of tax deductibility?  (And don’t forget, the interest paid will be going down every year as the principal is paid down and the standard deduction may go up, so you have less chance to reach that break-even point.)

I know it’s usually painful to think about taxes at all, but when someone is using an idea to sell you something, it’s wise to be informed and to have done a little of the math.  In reality the only decisions that should be influenced by the promise of tax deductibility are the ones made after you know that the initial $12,600 has already been met.

Words People Use

Early in my career my job involved administering a union contract, one that had a protection clause that was somewhat controversial.  Management called it “comparison” and the union and workers called it “regression.”  You only had to listen to the choice of words to tell where the speaker stood on the issue.

Since then I have become sensitive to the way others use words to try to influence me as I try to make rational decisions politically and economically.  In politics it’s more transparent, for example, some talking about inheritance tax and others about death tax, but there are a few in advertising that seem subtler.

One that is especially widespread is the substitution of the word home for house.  In general usage, a house is a structure where people might live.  A home on the other hand connotes something more personal, defined in one source as “the place in which one's domestic affections are centered.”  Accordingly realtors don’t sell houses any more; they sell homes.  We are enticed to look for new homes at a parade of homes.  It was a very clever marketing strategy to get buyers to think of the touchy-feely aspects of the transaction and react emotionally to “the home of your dreams” or to fall in love with a home, but it seems to have caught on everywhere.  I rarely hear people referring to the places where they live as their house.  It’s their home, and they may have a second home or a vacation home somewhere.  They buy homeowner’s insurance in case it burns down.  I wouldn’t be surprised if soon they don’t have a dog home in the back yard with a bird home hanging from the tree!  Does “the American dream of owning a home” imply that an apartment or rental property cannot be made into a home with love and care?  The real estate industry probably hopes so.  This has become so widespread that I recently saw a religious wall hanging saying, “Bless this home”, rather than using the traditional wording of house.

Of course there are others trying to change our vocabulary to their advantage including:  car dealers selling pre-owned cars as if to imply that someone only owned it for a while, but didn’t really use it; executives calling us associates instead of employees, then going out of their way not to associate with most of us – too important/busy for that; or restaurants and hotels calling us guests instead of customers.  (Well, if I’m your guest, why are you making me pay?)  I received a survey from a restaurant asking me to compare them to other “rapid service” establishments.  Maybe the term they used was “swift service,” but it definitely wasn’t “fast food”!  Good luck with that one!

It’s all a ploy to get us to switch off our Critical Thinking mechanism long enough to slip one by us.  I’d rather see the actions/results that they are trying to portray with these words than the fancy marketing terminology.