An update on Mr. Smith
Last week, I wrote a post about one of the myths surrounding "the rich," namely that there's this idea that about 1% of the population gets to live a super high consumption lifestyle at the expense of everyone else. Part of the work was focused around showing how someone with a relatively modest income could accumulate wealth into the millions of dollars while earning a relatively modest income, showing that many "tax the rich" policies may actually hurt middle class people who are in fact frugal wealth creators, i.e. the kinds of people who generate the wealth needed to start businesses, create productive jobs, and generally to keep the economy running.
At the end of the post, I wrote an Excel file to show how a rather ordinary person in an ordinary American household, who I called "Mr. Smith," can in fact save enough to retire comfortably and even become a millionaire.
Of course, models are never perfect, and with more time I'm planning to add in more controls so that we can better adjust Mr Smith's life story, what he does, whether he can live through retirement, and so on. I'm also planning some more work to improve the standard of living calculator to better reflect the last ten years of Mr. Smith's life, and to build in a function that includes costs like a stock market crash, kids going to college, etc. But for now, there are a couple of things you can very clearly see using this model:
- It is possible to earn less than $100,000 a year for most or all of your life, earn less than 10% on your investments, and still become a millionaire. Experiment to see the different ways this can be done.
- As taxes and inflation rise, Mr. Smith and his family need a higher interest rate (more return on investment) to maintain their standard of living. This is a great example of why even modest inflation forces people to move their money from safer savings and money market accounts, to riskier and more speculative places like the stock market.
- A 1% inflation rate can make Mr. Smith retire with less income than what he had in his 20s.
- You can actually see "The Laffer Curve" if you combine a wealth tax with a low income tax or with good investment returns (interest), and chart various wealth tax rates vs. tax collected. At 0% income tax, 5% interest, a $1 million wealth tax threshold, and income multiplier 1, the total collected wealth tax slows quickly at 8%, and peaks at 13%. This happens because high wealth taxes diminishes the amount of wealth available to tax.
- Wealth taxes and income taxes actually diminish total economic activity. This is because the taxes lower the amount of money has Mr. Smith saves, and lowers the amount he has invested. In effect, taxes for government spending in the present sacrifice wealth that would have been spent in the future.
- Lower savings rates also diminish total economic activity. Once again, spending in the present reduces wealth and spending in the future.
- In an environment of mild deflation, poorer people can afford to save and retire! 1% deflation is enough for a Mr. Smith earning 35% of the orginal model (0.35 multiplier) to have enough money to live through the model. That is a $35,000 a year household income at the peak; a very large number of Americans can do better than that; enough to support those who don't at low tax rates.
A few things to try!
One of the fun, but cruel things you can do with this calculator is come up with all kinds of ways to bankrupt Mr. Smith in his old age! Or, to be more kind, to come up with ways to make even a poor Mr. Smith be able to live to his 80s, or ideally to the end of the model at 90. Try different tax rates and income levels. See what mild (0 to 1%) inflation and deflation does in both real and nominal terms.
Also, if you have some ideas on how to improve the model or wouldlike to make improvements, feel free to comment and send me feedback! Areas where I need help the most is coming up with an accurate way to measure "inflation taxes" or wealth taken through inflation (which tends to end up in the hands of government and Wall Street banks), and better ways to model the standard of living and investments.
Download and try the life of Mr. Smith