June 25, 2014 by David K. Sutton
Tax Cuts For Job Creation? Do You Know How Compound Interest Works?
Never mind that it is consumers who create the demand for products and services that in turn generates the need for additional jobs to meet that demand. Yes, people need to start the companies that build the products, but let’s get one thing straight here, nobody would start a company if they thought there was no demand for a product. And nobody would start a company if they thought the general public had no purchasing power to buy their product. So jobs will always be a function of demand, not supply.
But this article isn’t about economic arguments over supply and demand, it’s about the power of compound interest, and why this single concept needs to be understood so that we can move past frivolous arguments about what it takes to create jobs. I believe if people really understood the power of compound interest, and I mean REALLY understood it, they wouldn’t support things as ridiculous as tax cuts for the rich for the purpose of job creation (or any purpose). If you have a lot of money, the last thing you need is a tax cut to do anything. You already CAN do anything if you so choose. If you have a lot of money, you already generate enough income on interest alone to fund a lavish lifestyle. And no, this isn’t about class warfare, or eating the rich. It’s just simple math combined with a little bit of logic and reasoning.
There’s no bigger wealth creation tool available then already being wealthy. Even a modest 3% or 4% interest rate on large sums of money generates incredible returns. Take 4% on $1 million (with no additional deposits), which will then generate another $1 million in less than 18 years. Again, this is completely passive. Start out with a million in that account bearing 4%, end up with $2 million 18 years later, no additional deposits required.
Or how about an interest rate a bit higher, like one you might expect to get if you invested heavily in equities, instead of something safer like bonds. Let’s say you earn 7% instead of 4%. I haven’t done extensive stock market analysis, but I’m fairly certain that over most 18 year periods, the stock market has returned 7% or more. There are always exceptions of course, but let’s see what that $1 million does at 7% over those same 18 years:
Look at that growth! Earn 7% over 18 years, and $1 million turns into $3.5 million. And you can really see how the interest portion of the chart is really starting to take off in the last few years. The curve gets steeper and stepper. In this scenario, it only takes an additional 10 years to double that $3.5 million to $7 million. So in 28 years, $1 million turns into $7 million, and this is with an interest rate (7%) that is well below the 100+ year average for the stock market (10%).
So what’s the point of all this? Well, first, it should offer you some motivation to start saving now instead of waiting until later. The power of interest and time is pretty incredible. Second, yes, $1 million is a lot of money, and so you might find much of what I’ve said so far to be foreign to you. But this is all the more reason to NOT support the kind of tax incentives we offer to people who make (and have) much more than $1 million. It’s simply ridiculous to think that people with large sums of money will in turn do something particularly helpful for society if we just offer them that one last tax break. When you can already generate an insane amount of additional wealth by doing nothing but investing your existing wealth, what motivation does a tax cut give you to do anything?