In 1626, Dutch settlers, led by Peter Minuit, bought Manhattan Island from the Canarsie Indians for $24.
Is this a case of the Dutch taking advantage of the aboriginals or the aboriginals taking advantage of the Dutch?
In the early ‘90’s I did some consulting work with first nations in Ontario and Quebec. As you can probably imagine, this question never came up.
Assessing it will help you understand why you cannot let the government charge taxes on investment income that you will re-invest.
Suppose in 1626, the Canarsie had taken their $24 over to JPMorgan Chase and left it invested there at 8%. Today, 386 years later, it would be worth $191,329,000,000,000. 191 trillion dollars. About the value of all financial assets in the entire world.
At the beginning of 2012, the total value of all 1,000,000 parcels of real estate subject to municipal taxation in New York City was $845,000,000,000. That is all of New York not just Manhattan. The detail does not matter, for the point is clear. Today, the Canarsie could buy Manhattan back and get a lot of change.
Just this year’s income would be about sixteen times the value of New York City.
Clearly the Dutch got beat up rather badly.
But, suppose the Canarsie had to pay income tax at 45% on their money. With tax, their yield is only 4.4%. That would create a value now of just under $4 billion. Nice money, and you could probably buy the New York Yankees, their TV network, the stadium and a nice condo with it. Not a lot more.
What does that mean?
It means that over a long time the government gets all the money.
Of the $191 trillion that was possible, after taxes were lost, only $4 billion was left to the owners of the money. That is less than two thousandths of 1%. A long term tax rate of 99.998%.
Surprisingly, the tax rate does not matter much. Even at a 20% nominal rate, the Canarsie would have lost 99.95% of their potential profit.
Taxes compound too!
The moral of the story. Even though you likely do not have a 386-year investment horizon, you need to pay attention to the fact that time and yield matter more than the amount of capital employed. Do not allow anything you can control to reduce your yield. Especially do not pay more taxes than necessary on money that you intend to invest.
Work at it. It matters.