The financial sector is a tricky subject, full of jargon and twisted terminology that doesn’t make any sense at first.
To get a better understanding of the role of taxes in the financial industry, it’s best to take a step back and analyze what leakage factors mean.
According to Investopedia, “A leakage factor is an opposing factor that depletes or reduces funds.” In other words, this refers to taking money out of something before putting it back in later on.
On the surface, this may seem like good practice because it returns resources as much as possible but with so many dangers involved with leakages—reasons why taxes are considered a leakage factor—we don’t recommend relying solely on them for your finances.
Even if leakage factors work as expected, they are a liability that can come back to bite you as stated by Investopedia: “The effectiveness of a leakage factor versus the gain in net profit may not be worth the risk if there’s an alternative method to return more money.”
In the case of investments and savings, this is referring to how taxes play into these processes.
We’ve read some books on financial terms and we understand what tax leakage factors mean in more detail than that, so we’ve compiled a list of resources for you to read through and better understand why taxes can be used for leakages.
This will help you understand where your money is going when you invest and why saving should not be based solely on them.
which best describes why taxes and savings are considered leakage factors?
1. Taxes make it difficult for money to earn interest –
This is a common example that we hear used to describe how taxes affect financial strategies and investments.
In short, money gets taxed when you invest, so your money is essentially getting pruned while it makes time for its growth.
2. Taxes are the reason why you have to pay the price of the item first –
This one’s pretty straightforward. For instance, if you’re buying a car and don’t have enough money to purchase it at full price, then you’re going to have to pay taxes on the difference of your total cost and total purchase price.
This also applies for house purchases–if you can’t afford the full amount at once then you’ll have to pay taxes on that difference as well.
3. When you get a loan, the interest you pay is not taxed –
This is a misconception that people may not understand. In most cases, there are hidden fees attached to loans that are included in the interest rate—this is called the origination fee.
These fees are not mandatory, so loans can be granted without them.
This means that if you pay interest on a loan and have to pay origination fees separately then your payments are still being taxed, even if it isn’t shown when you sign the loan contract.
4. You get hit with taxes every time you spend money –
This is a fundamental misunderstanding of how a leaky tax system actually functions. The way you pay for things doesn’t necessarily explain how one could be considered a leaky factor.
Let’s say you purchase 5 packs of gum for $10 each; if you pay using credit card, then the taxes for each pack will show up separately as shown below:
5. Taxes are used to reduce the profit made by businesses –
This is one we hear commonly which shows that people don’t know what they’re talking about when it comes to taxes and finances.
We understand how a business can be taxed, but charging taxes is not how profit is reduced.
The money you pay in taxes can not be used to reduce profits and business owners have to use their own money (or borrowed money) to compensate for the difference.
6. Taxes are used as a way of discouraging certain behavior –
As stated above, people don’t understand how leaky tax systems work which leads to some wrong assumptions.
Taking money out of the financial sector does not necessarily discourage those who are taxed from making decisions–it’s only an option for them if they want to use that money for other things instead of investing or saving it.
7. If businesses didn’t have to pay taxes, they could provide better service –
This doesn’t make sense because if businesses didn’t have to pay taxes, then they would be making more profit and wouldn’t have to cut costs–that means they’d be paying you less for your job.
It’s the same way a company that has profits distributed among its employees makes more money than one where employees are paid the same amount but each gets a share of the profits: in this case, the latter company is doing better for itself and its shareholders.
8. Leaky taxes are used to promote savings and investment –
This is true: if someone is saving money, then they’re not spending it. It’s not a bad thing at all and we shouldn’t be discouraging saving because of how leaky tax systems work. If anything, the government wants you to save money.
