Wealth tax vs Income tax: Why rich people pay less taxes than you

I’ve slowly come to the realization that one of our household’s main expenses was tax. I’ve always felt taxes couldn’t be avoided unless you “game” the system, and, in a way this was true, but I’m progressively understanding how the game is played.

If you’re still in the rat race just like me, there might have been a phase in your life where you thought you should make more money. But the thing is, in many countries (including France, Japan, and the US, 3 countries in which I’ve lived and paid taxes), the more you make, the more your additional income gets taxed. And because of that, as your salary increases, you have to make way much more to actually significantly increase your income.

I’ve discussed before how it’s much more easier to reduce your expenses than increase your income in general, and this is true in particular because of taxes.

So here’s the revelation of the month for me: taxes don’t impact rich people, they impact people with lots of income! If you’ve ever looked a bit closely into your investments, this is no news for you, and you can probably stop reading here. But as I discuss with friends in their mid thirties, I clearly see that people are not really understanding how the tax game is played. Many of them don’t understand the difference between being rich and having a high income.

People think they won’t ever be able to retire early, because (among other things) they imagine they will always need the same amount of income, therefore have to pay the same amount of tax. But the truth is, you need a high income (and therefore high tax rate) only in your “accumulation” phase, when in addition to pay for your daily life, you also need additional money to save.

However, once your financial goals are achieved, you can finely tune your income to your actual expenses, dramatically reducing your tax level. This is probably why the wealthy are not afraid of taxes, in particular if they adopt a frugal lifestyle. (and to be clear, I’m talking about upder-middle class here, not the people rich enough that they have people optimizing their taxes for them)

This is why investment needs to be done carefully: your stock, or other investments, should be handled in a way that your “realized income” is always as minimal as possible, and only when needed. This implies being clever when rebalancing your investments, as well as when selling it to support your lifestyle. I’ve been majorly bad at this so far, and I know I need to improve.

This approach is valid for the countries that do not have a tax on wealth, only a tax on income. Thankfully, they are the majority today. Wikipedia has a list of countries with a wealth tax, that you might find useful.