Tax Aversion Bias
By Charlie Mattingly
We often talk about behavioral biases, and we are constantly trying to better understand behavioral finance and behavioral economics to make better decisions. We think it’s fascinating because it can have a huge impact on our investment returns, saving habits and therefore our success in retirement.
Another one of the things that it affects tremendously, believe it or not, is taxes. So how does paying taxes drive our behavior?
First, let me talk about behavioral biases. What do we mean by behavioral biases? Certain parts of our brains are wired to make snap decisions to help save our lives, and sometimes this quick thinking really does save your life. What I’m referring to is the limbic system. This system is the emotional center of the brain that takes over under stress. The limbic system is the part of the brain involved in our behavioral and emotional responses, especially as it pertains to behaviors we need for survival, feeding, reproduction, caring for our young, and fight or flight responses.
This system has no doubt led to our advancement and survival as a species, however it often fails when tasked with evaluating certain complex scenarios we face in modern society, especially those that are highly emotional such as our finances.
So, what I wanted to do is address some of the weird things we do as taxpayers to avoid paying taxes.
Of course, there’s nothing wrong with minimizing your taxes. We don’t want to pay one cent more than we’re legally required to, on the other hand, we don’t want to reduce our net worth just to minimize taxes. Unfortunately, that’s what happens a lot of the time.
My father-in-law owns a lake house here in the Knoxville, Tennessee area. The house is paid off and it has appreciated significantly in value over the years. It’s a beautiful place, but they don’t want it anymore. It’s a lot of work for them to properly maintain. So, maybe selling the property would bring them more peace of mind and less stress in retirement. However, he won’t sell it. The primary reason is because he’ll have to pay taxes.
What other ways has the tax aversion bias changed our behavior? Taxfoundation.org has a great article on some of these examples of tax aversion bias.
Have you been to Charleston, South Carolina and noticed that the buildings are narrow and close together? That design started in Amsterdam and was copied around the world. The buildings were intentionally built to be narrow because… you guessed it, taxes. In the 16th century, buildings in Amsterdam were taxed by the width of the property’s façade and how much street frontage they took up.
Real Estate Investing
Another fascinating example from Paris, is the design of the Mansard-style roofs. Architects actually created rooms above the roof line because taxes were levied on the number of floors below the roof line.
Mansard Roof
One of these behaviors that I struggle with and think about a lot is farm equipment. I’d like to buy a new tractor and I know a lot of you probably would too. Tractors are fun! That’s why towards the end of the year I hear folks say, “Hey, I need to reduce my taxes, so I’m going to go buy a tractor. Maybe even a bigger tractor!”
Again, if you need the tractor or farm equipment, that’s a different story, but don’t do things simply because it’s a tax savings. As my business partner, Kevin Gormley will tell you that’s the “tax tail wagging the dog”.
In summary, taxes are a very emotional issue, and this can affect our behaviors. Sometimes we let our emotions make decisions for us, such as the example where I’m not going to pay taxes no matter what or as little as possible no matter what. Just be aware that even though its painful, sometimes it might be smarter to just pay that tax.
Thank you for reading. Please reach out to us anytime. Leadingedgeplanning.com, My email is Charli@leadingedgeplanning.com. We’d love to hear from you!
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this video will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any information or any corresponding discussions serves as the receipt of, or as a substitute for, personalized investment advice from Leading Edge Financial Planning personnel. The opinions expressed are those of Leading Edge Financial Planning as of 09/06/2019 and are subject to change at any time due to the changes in market or economic conditions.