Understanding the Mathematics of Personal Finance

Taxation and Inflation

John Lennon once said, “Life is what happens to you while you’re busy making other plans.” Both taxation and inflation, it seems, are parts of life—they happen to you while you’re busy making other plans.

Taxation is the government’s way of getting money to pay its bills. You pay taxes on, among other things, your income; earned interest may be considered part of your income. The government (federal, state, and local) all want a piece of this income, so you get to keep and spend or save less than what all of the calculations thus far have promised you. On the other hand, interest on some of your debts is considered to be a deductible expense. That is, you get to reduce the income you report to the government, from which your tax burden is calculated, by this interest.

Inflation is not a phenomenon that takes money away from or adds money to your bank account. Instead, inflation reduces the spending power of your money. Out of control inflation rates can be disastrous to a country’s economy, so the gov­ernment watches it and tries to control it very carefully. There are circumstances where inflation can work for you. These circumstances will be discussed later on in this chapter.

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