By Dr. James M. Dahle, WCI Founder
One of the most important principles of economics is that people respond to incentives. That makes it unfortunate that there are so many things in life that incentivize us to earn less money. These “perverse incentives” or “moral hazards” can result in lower tax revenues, fewer goods and services available, and less general prosperity. As a general rule, you incentivize what you want to see more of (classic examples in our economy are education and healthcare) and you tax what you want to see less of (tobacco and alcohol, for instance.) Since we tax income, that results in, you guessed it, less income.
However, there are far more incentives to make less money than just taxes. Today, let's go through all of the ways we are incentivized to make less money.
#1 Lower Marginal Tax Rates
The most noticeable way that we are all penalized for making more money is that additional income is taxed at ever higher rates. If you earn $30,000 and make an additional $100, you lose $10 or $12 of it to the taxman. If you earn $3 million and make an additional $100, you lose $37 of it to taxes. It isn't JUST that you pay more taxes, it's that you also pay a higher percentage of your income as tax. I'm not saying this is right or wrong; I'm simply pointing out that this is the way it is, and it has consequences.
More information here:
#2 Free Capital Gains
Lower earners don't pay capital gains taxes. At all. Make less, pay less.
#3 More Tax Credits
The less money you make, the more tax credits you become eligible for. Here is a list of common tax credits:
- Earned income tax credit
- American opportunity tax credit
- Lifetime learning credit
- Child and dependent care credit
- Child tax credit
- Savers tax credit
- Recovery rebate credit
- Adoption credit
Many of my readers are phased out of most or all of these credits. If you make a million bucks a year, you don't get any of them.
#4 More Tax Deductions
It isn't just tax credits that get phased out. You do for tax deductions as well. Consider these common deductions that get phased out at higher incomes:
- Student loan interest deduction
- IRA deduction
- Education tuition and fees deduction
- Property and state income taxes (higher earners generally have more property/state income taxes, only $10,000 of which can be deducted)
- 199A deduction (for specified service industries)
#5 PPACA Subsidy
Bought health insurance on your own? Then, you're probably aware that it is MUCH cheaper for some people than others. For example, a family of four with an AGI of $40,000 gets a $4,618 per year subsidy to help offset the cost. A family of four with an AGI of $140,000 doesn't get squat.
#6 Medicare Part B IRMAA
Whether you call it a subsidy for low earners or a fee for high earners, the Medicare Part B Income Related Monthly Adjustment Amount (IRMAA) means that some people pay $6,060 more for Medicare Part B than others do.
#7 Lower IDR Payments
Income Driven Repayment programs like IBR, PAYE, and REPAYE are based on, well, income. The higher your income, the higher your payments.
#8 Lower REPAYE Subsidy
If your calculated REPAYE payment becomes larger than the accrued interest on your student loans due to a higher income, then you no longer get your interest rate subsidized.
#9 Additional Forgiveness
Whether you are going for PSLF or IDR forgiveness, the lower your payments, the more of your loan that will still be left to forgive. With IDR forgiveness, the tax on that forgiveness is also lower due to your lower marginal tax rate.
More information here:
Student Loans 101: Ultimate Guide to Student Loans
#10 Pell Grants
Pell grants to pay for college are not available to high earners and their children.
#11 More Private Financial Aid
Colleges and other entities that offer scholarships, grants, and loans often restrict most of those to people with a calculated need. Some elite schools don't charge tuition at all to students from families with less than a certain income.
#12 Fewer Government Support Programs
Nobody should be surprised, but high earners don't qualify for government programs designed for the poor, including food stamps, Medicaid, CHIP, Temporary Assistance for Needy Families, supplemental nutrition assistance, housing assistance, Supplemental Security Income, or Social Security Disability (only earned income counts).
#13 No Estate Taxes
While not specifically phased out for high earners, high earners are far more likely to build wealth than low earners. Estate taxes really incentivize you to not build wealth, not necessarily to earn less money. But they're pretty closely related activities.
More information here:
Estate Taxes: Federal, State, and Inheritance Tax Rules Explained
#14 Can Contribute Directly to Roth IRAs
High earners can still contribute through the Backdoor Roth IRA process. But some high earners can't do that because they'll get pro-rated, and there are other high earners who can't seem to do the workaround properly.
#15 Can Contribute Directly to Coverdell Education Savings Accounts
While 529s have no income limits on contributions, ESAs do. OK, this isn't a big deal, but it is one more tiny incentive to earn less.
#16 Ability to Use Savings Bonds for Education Tax-free
Guess who can't cash out their savings bonds without paying taxes on the earnings if the proceeds are used for education? That's right, high earners.
#17 Payouts from Stimulus Packages
Remember that stimulus check you got in the spring of 2020 and 2021? Me neither. Again, not saying it's right or wrong; it's just the way it is. One more way you are incentivized to earn less.*
*To be honest, business owners generally received far more money than their employees as part of these packages. Those people are generally, but not always, higher earners. I'm sure there are at least a few people out there that got both types of stimuli-personal and business payments.
#18 Social Security Income Taxation
Eighty-five percent of Social Security income is taxable. Unless you earn below a certain amount. Then, it is tax-free. At least it's not 100%.
#19 Additional Medicare (PPACA) Taxes
High earners pay an additional tax of 0.9% of earned income and 3.8% of unearned income.
#20 People Hate You Less
There are a lot of people in this country that really, really hate “the rich.” They don't necessarily define it by whether the rich are wealthy or whether they are high earners, but it honestly doesn't matter, does it? Here are some examples:
Some people just want to kill the rich. However, others won't stop there. They actually want to eat them, too. Even high earner Steven Tyler wants to partake in that activity. People got especially hungry during the meme stock phase of 2021.
I found these hashtags somewhat fascinating. I actually searched to see if anybody was advocating for killing and eating the poor (they weren't, at least not for the last few centuries). Granted, a large percentage of these people are presumably joking and/or speaking metaphorically. But it only takes one.
At any rate, this is one great incentive to earn less. You can “fit in a lot better with regular people” and nobody is going to try to kill or eat you. Envy can be ugly—and maybe even violent too.
OK, let's get real here for a minute. Yes, there are A LOT of ways in which you are incentivized to earn less. Even very wealthy people respond to these things. Just read a few FIRE blogs for a couple of months, and you'll find bloggers showing you how to get PPACA subsidies, avoid IRMAA fees, and score Saver's Credits. But the truth is that there is also a lot of incentive to earn more. The main one is that when you earn more, you have more. Remember that extra $37 in tax that the million-dollar earner had to pay for that extra $100 in earnings? They also got to keep $63. They could do anything they want with it. They can spend it, save it, invest it, or give it away. In fact, if they give it away to charity, they don't even have to pay that $37 in taxes on it.
I definitely prefer the financial freedom, security, opportunities, and ability to help others that come with being a high earner—despite the plethora of incentives to earn less.
What do you think? Did I miss any other incentives to earn less? Have you changed any of your habits or plans in response to these incentives? Comment below!