Reducing Your Expenses Is Better Than Increasing Your Income

July 8th, 2008 · No Comments · Subscribe to this feed

It may seem controversial to say something like “reducing your expenses is better than raising your income.” After all, who doesn’t want more income? Of course, more income is always better than less, even taking taxes into account. Every dollar earned increases your after-tax income at least a little. The problem is, due to our progressive tax system, you keep less and less of each additional dollar earned. The more you make, the more Uncle Sam takes. You can argue about whether or not you think this is fair all day long (for the record, I do), but the fact remains that after you’ve reached a certain income level, taxes are likely to be your largest household expense every year.

A Penny Saved Is Two Dollars Earned

Remember Ben Franklin’s famous line, “a penny saved is a penny earned?” That was true before there was an income tax, but it’s not anymore. In fact, these days a penny saved is worth significantly more than a penny earned. This is because every dollar you earn is taxed before it even gets to your pocket.

It’s obvious a penny saved is worth more than a penny earned, but just how much more? Jonathan over at My Money Blog concluded a penny earned is worth only about 58.05% of a penny saved assuming your’e in the 25% federal tax bracket and 9.3% state tax bracket (this obviously varies from state to state). If you’re in the 35% tax bracket, a dollar earned will be even less while if you’re in a lower bracket, it will be worth more. But no matter how you look at it, a penny saved is worth significantly more: as much as 100% more in some cases.

Say you make $50,000 per year and save nothing; that is, you spend all your take-home pay every month with nothing left over. You would be much better off reducing your expenses by $5,000 than increasing your income by $5,000 because after taxes, that $5,000 would barely be worth $3,000. The $5,000 you saved by reducing your expenses, on the other hand, will always be $5,000. Obviously, it’s better to both reduce your expenses and increase your income, but one step at a time! Some pundits, like Robert Kiyosaki (author of the Rich Dad, Poor Dad series) argue otherwise. They think it’s better to concentrate on increasing your income rather than reducing your expenses. I disagree. While raising your income is great, it’s just not practical for many people, especially those who live in areas where maybe there aren’t as many economic opportunities as others or those without advanced academic degrees. People with limited opportunities for advancement would be better-served in the real world by concentrating on reducing their expenses.

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