Benjamin Franklin allegedly said that a penny saved is a penny earned. In other words, saving money on an expense frees up just as much purchasing power as earning the same amount of money. Makes sense, right? However, Benjamin Franklin also allegedly said that nothing is certain but death and taxes. Which seems to be true. But this is where he contradicts himself. Because of taxes, a penny saved is actually worth significantly more than a penny earned.
Why The Difference?
When you save money on something, the penny saved is after-tax money. You’re able to spend the entire savings somewhere else. If you use a 10c/gallon coupon on gas and save a dollar on that tank of gas, you’re able to spend the entire dollar somewhere else. Or if you re-quote your car insurance, and score a $200 annual savings, the entire $200 can go somewhere else in your budget.
When you earn money, however, your money is taxed. If you pick up an extra job as opposed to looking for savings, your actual earnings will be significantly less than your quoted wage. For example, if you make $15/hr at your side job, you very possibly could see only $10 for every hour you worked, meaning you’d actually have to work an hour and a half to see the whole $15.
How Much in Taxes?
The amount taxes will take out of extra income really varies from individual to individual and from state to state. Your tax rate depends on exemptions, state taxes, deductions, credits and tax brackets.
But don’t look at your overall (effective) tax rate. We’re comparing a penny (or dollar or hundred dollars) saved against the same amount earned on top of your regular pay. This is what’s known as your marginal income. Your marginal income is taxed at your top tax rate- or where your total income for the year lands on the tax table.
If you have an income under $50,000/year, your effective federal tax rate is likely somewhere around 6%. This is the average you’re paying on your entire income. However, your marginal federal tax rate is still 25%. This is what you pay on every additional dollar you earn. Add FICA taxes and your state marginal tax on top of that and you could easily be paying 40-50% of every additional dollar earned!
Granted, some people will have lower total marginal tax rates. And some people will have higher marginal tax rates. But if your marginal tax rate is indeed 50%, you’d need to earn two dollars to get the same bang for a dollar saved. In other words, a penny saved is as good as two pennies earned!
So Is Spending Less Better than Earning?
Spending less vs. earning more is a never ending debate in the personal finance community. Surely this post proves that saving is better than earning, right? After all, money-saving hacks perform twice as well as earning more! Not so fast.
Taxes are only part of the picture. You also need to consider the time and effort put into saving vs. into earning more. If you can earn three times as much as you could have saved in the same amount of time, perhaps earning more is better. On the other hand, if you can save money by doing something you enjoy, this might be better.
This is why a high earner might choose to hire a house cleaner or a cook. Although spending an hour cleaning their own house or cooking their own meals may have saved them money, they will make far more money in the same hour, even after taxes. However, another person making the same amount might choose to cook their own meals because this is an activity they enjoy.
On the flip side, if you make $15 per hour, paying someone $15 to do something you could have done in an hour doesn’t make sense. You would have to work two extra hours to make the after-tax $15 to pay the person, instead of spending one hour doing it yourself. And spending fifteen minutes to save 15% or more on car insurance is a no-brainer, assuming you actually save 15% or more.
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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.