The Four Different Ways To Spend Money By Milton Friedman

The reason why Warren Buffet is so great is because he’s able to distill the most complicated financial topics into very simple terms.  Lucky for us, there is someone like Warren in the economics world.  Regular reader, Investor Junkie who disagrees with the government’s unemployment insurance extension, but agrees with the cessation of rising taxes, highlights a fantastic video by the great economist Milton Friedman about four different ways of spending money.

Professor Friedman’s examples are simple and perfectly to the point.  In an environment where we are spending other people’s money on someone else (deciding how other people’s tax dollars are spent), we don’t maximize the value of the dollar because we simply don’t have much at stake.

Professor Friedman highlights that people spending someone else’s money on others is a “distributor of welfare funds.”  Strong words with a certain amount of truth wouldn’t you agree?  In “The Ultimate Solution To A Fair Tax Policy In America”, I discuss the concept of limiting the voting ability of the 47% of non tax paying Americans on raising taxes for the other 53%.   Don’t worry, voting rights for everything else is status quo.  The reason why I suggest this rational solution is because it makes sure the country isn’t overrun by those who have their cake (don’t pay taxes) and get to eat it too (enjoy the benefits).

One can easily see an America where 90%+ of citizens don’t pay taxes and stick it to the 10% rich because it’s rational to look out for your own interests.  It’s up to balanced people who believe in equity to continue fighting for those who perpetually get unfairly blamed for our economy’s problems.  It really is ironic, because if everybody studied hard in school, volunteered their time to help others, and were self-sufficient (doesn’t have to be wealthy), America wouldn’t have nearly the amount of problems we have now!

The 4 Ways Of Spending

1) Spend your own money on yourself.

2) Spend your own money on somebody else.

3) Spend somebody else’s money on yourself.

4) Spend somebody else’s money on somebody else.

Readers, do you agree or disagree with Professor Friedman’s thesis that the 4th way of spending is the worst way of spending?  If you do agree, why do you think people feel it’s OK to spend other people’s money as they wish?

Regards,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

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Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Investor Junkie says

    Of course I agree with Uncle Milton. His 4 rules of spending while great, isn’t 100% accurate 100% of the time either. That’s why economics shouldn’t be considered a science either no matter how dismal.

  2. Everyday Tips says

    As a side note, I also hate how people whine about the President or whoever, and yet they never voted.

    Anyway, I put myself through undergrad/graduate school so I could take care of myself and be a contributor to our families finances. I never even considered to be benefiting from options 3 or 4. Personally, I want the control of my finances which is why the status of social security drives me insane. (I am making a lot of people socially secure, who deserve it because they put into the pot. But who will make me socially secure in 25-30 years? I am guessing nobody.) The fact that it is ok for people to not have their ducks in a row and the ‘rich’ should come in and fix everything is perplexing to me. I don’t want people to suffer, don’t get me wrong, but I want people to be responsible. I am all for programs that help the disabled and the unemployed. But I think we have real flaws in our country when we have systems set up for people to walk away from their mortgages that they can fully afford and such.

    Did my rant even address your question? I don’t know…

    • admin says

      Oh come one… you don’t want some fat cat politician spending your money for you? You KNOW they have your best interests at hear right?

  3. Larry says

    Funny you should mention Warren, as he plays directly into the previous discussion:

    http://www.washingtonpost.com/wp-dyn/content/article/2007/06/27/AR2007062700097.html?hpid=sec-politics

    Buffett Slams Tax System Disparities
    By Tomoeh Murakami Tse
    Washington Post Staff Writer
    Wednesday, June 27, 2007

    “Warren E. Buffett . . . slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

    “Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

    “Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. ‘I don’t have a tax shelter,’ he said.

    “Buffett said that he and other privileged Americans must do more to help the less fortunate. . . . Buffett said he thought Democrats would do a better job in evening out the field for those who had drawn the unlucky tickets in life.”

    Yep. The reason why Warren Buffet is so great is because he’s able to distill the most complicated financial topics into very simple terms.

    • IGotBupkis, Legally Defined Cyberbully in All 57 States says

      Buffet never notes how it is that he manages to pay so little — and the answer is the scam that was set up as a hiding place for the uber-rich even back BEFORE the income tax became a reality: Tax Free Foundations.

      That’s right, increasing tax rates won’t hurt him one whit.

      The uber-rich put all their money into these Foundations (which are designed so you pretty much MUST be uber-rich to take advantage of) — The Kennedy Foundation, the Rockefeller Foundation, the Bill & Melinda Gates Foundation (Buffet’s own foundation has been mostly melded into B&MGF, and the rest melds into it when he dies).

      The uber-rich like Buffet still control it, they still decide how it’s spent, what it invests in, and so forth — And as directors they take full advantage of assets owned and controlled by it… but it’s not “theirs” and any “income” it creates stays “in the foundation” and generally isn’t paid out to the owner/directors … that would result in an income tax.
      .
      .
      .
      .
      The reason why Warren Buffet is so great is because people are stupid enough to listen to what he says and believe anything he tells them is the full and complete truth.

      Increasing income taxes doesn’t do $^^%$ to the uber rich, THEY DON’T HAVE INCOMES.

  4. Larry says

    Funny you should mention Warren Buffett, as his views play into the previous discussion:

    Buffett Slams Tax System Disparities
    By Tomoeh Murakami Tse
    Washington Post Staff Writer
    Wednesday, June 27, 2007

    “Warren E. Buffett . . . slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

    “Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

    Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. . . . [He] said that he and other privileged Americans must do more to help the less fortunate. . . . Buffett said he thought Democrats would do a better job in evening out the field for those who had drawn the unlucky tickets in life.”

    Yup. The reason why Warren Buffet is so great is because he’s able to distill the most complicated financial topics into very simple terms.

    • admin says

      I agree. Buffet makes the majority of income due to dividends. We need to raise the dividend tax from 15% to 20-30% and capture Warren and other folk’s money.

      We might also capture the money of many more retired folks who are living off of dividend income in their portfolios in Florida, Hawaii, and Nebraska, but that’s the collateral damage which Buffet and many are willing to take.

      It’s always awesome to hear billionaires tell the world we need to pay more taxes, when if you take away 99% of their wealth, they are 99% more wealthy than everyone else. Love it!

      • Investor Junkie says

        As much as I like Warren, he speaks from both sides of his mouth. He favored the
        bank bailouts, why though? To aid in his GS investment. If he really wanted to pay more
        taxes he could, but does he? I would be willing to bet he doesn’t pay a dime more
        than he has to.

        • Michael Harr @ TodayForward says

          His being in favor of TARP and related bailouts including extraordinary action by the Fed had more to do with preserving the American economic infrastructure than his small investing in Goldman. Besides he’s already given away virtually his entire fortune so simple, selfish greed is an unlikely motivator.

          To your point that he likely didn’t pay a dime more than he has to…Chief Justice Renquist had been quoted as saying ‘everyone must pay their fair share of taxes, and not a penny more’ or something along those lines. All tolled, I would rather have him giving any ‘extra’ money to the Gates Foundation than to Uncle Sam.

          Both sides of his mouth? I don’t see it.

      • Larry says

        I don’t know where you stand here, Sam. Buffett favors wealth distribution by raising taxes on the rich.

        Also in any discussion of tax cheats/dodgers, I think you have to consider the huge corporations like GE, ExxonMobil, etc., who pay no federal income taxes and even get sizable refunds. There’s your real greed right there, not the poor family earning $30K getting a break from the Earned Income Credit.

        Sorry for the double post. I thought my first one didn’t go through.

        • admin says

          I stand by the fact that we should always do the right thing, and look out for our fellow brothers and sisters.

          GE, EM pay enormous amounts of tax. Just look at their financial statements. What kind of sensationalist comments are you posting now?

        • Larry says

          My sensationalist comments come from that left-leaning liberal rag Forbes Magazine, which gives plentiful instances of how the top 25 US corporations manage – through overseas operations, net operating losses, research and investment credits, and the like – to avoid paying federal income tax (remember, that was the subject here) at the same rates as “our fellow brothers and sisters” (remember, the Supreme Court recently decided corporations were people too, just like you or me):

          http://www.forbes.com/2010/04/01/ge-exxon-walmart-business-washington-corporate-taxes_slide.html

          None of ExxonMobil’s income taxes were paid in the U.S.

          Over the last two years, GE Capital has displayed an uncanny ability to lose lots of money in the U.S. and make lots of money overseas, where tax rates are lower.

          How did Bank of America not pay any taxes on $4.4 billion in income? Because of deductions like $860 million in tax-exempt income, $670 million in low-income housing credits and a $600 million loss on shares of foreign subsidiaries. With a provision for credit losses of $49 billion, Bank of America probably won’t be paying taxes for a long time.

          Ford’s tax rate is so low because of past years’ losses from U.S. operations.

          HP’s low tax rate is due to lower tax rates in foreign countries. The company says in its annual report that President Obama’s proposals to end tax deferrals on international operations would mean a big tax hike.

          Verizon’s low tax rate is due to its $42 billion wireless joint venture with Vodafone, which draws off much of Verizon’s income.

          Big Blue pays 49% of its income taxes overseas. In Japan it is appealing a $330 million tax assessment that followed an investigation into alleged tax evasion.

          With $17.5 billion in future tax deductions and credits on the books, and a $39 billion provision for loan losses, Citi has many tax-free years ahead of it.

          More than half of P&G’s business is overseas.

          Domestic-only retailers like Kroger have some of the highest tax rates among big companies because they have no lower-taxed overseas income to bring rates down.

          Of the companies in this list, Costco can be proud of having the most straightforward (and refreshing) financial statements.

          Boeing’s lower tax rate is mostly the result of big research and development tax credits.

        • IGotBupkis, Legally Defined Cyberbully in All 57 States says

          }}} – through overseas operations, net operating losses, research and investment credits, and the like – to avoid paying federal income tax

          Why in GOD’s name would a corporations’ activities overseas be expected to generate income taxes collected by the US government? What is the US Government doing for them THERE?

          Why do you think a company doesn’t pay sales tax to Florida on a business transaction that takes place in Colorado with a buyer in Indiana? For it to be otherwise is just ludicrously absurd.

          But somehow you figure GE should pay taxes on money made overseas for stuff that never comes into the USA? Ridiculous!

          Talk about mindless greed — pro-government types have it hands down more than anyone else on the planet, just like any other thief in the night. :-S

  5. Roger, the Amateur Financier says

    Hum, that’s a tricky one. I’ve heard his argument before, and I do understand his point (when we’re spending money on ourselves, we try to maximize what we get from the spending, when we spend our own money, we try to minimize our spending). I think that the worst type of spending, though, would be spending someone else’s money on ourselves; if we aren’t getting a piece of the pie, we might limit how much we spend on other people (because, as Friedman said, we don’t care very much about how they enjoy the money), whereas we can probably come up with a near endless amount of things we’d like to spend (someone else’s) money on for ourselves. (Plus, spending other people’s money on ourselves fits better with your complaint about non-taxpayers controlling what happens to government funds, anyway; they’re getting the benefits of the spending (having it spent on themselves) without it being their money.)

  6. ctreit says

    Among other things, Friedman says that the problem is that you are not as careful about how you spend money if you spend somebody else’s money. That is why we have such a bloated government system that keeps tabs on spending other people’s money. In the meantime this bloated system swallows up a lot of money that could be put to much better use. Rose and Milton Friedman think that the private sector would do a much better job. They propose in “Free to Choose” that almost everything should or at least could be privatized. I am not sure (a) that private initiatives can actually perform many of traditional government tasks like defense, roads, etc. and (b) that they can do it much more efficiently, i.e. putting the money to better use while still turning a profit. Another problem is (government) regulation especially of natural monopolies. How private is a heavily regulated business anyway?

    • admin says

      Good point on how private is a heavily regulated business anyway. I think about the banks when you ask this….. and the answer is, not very!

  7. Charlie says

    Agree it’s sad that the schools get screwed even though they are so important. I like how he makes things so simple. I hope someday we can be proud of how our tax dollars are going towards a strong public school system instead of disappearing in the middle east.

  8. Roshawn @ Watson Inc says

    It is unjust to tell someone else how to spend their money. Although I seriously wonder how many of the 47% who don’t pay taxes can really afford taxes, at least with what the tax rates are.

  9. Barb Friedberg says

    Hi Sam, As a former econ major in college I love anything by Miilton Friedman. I loved the formulation of the clip. IT IS SO TRUE. To be able to harness those concepts into practice in our government would be monumental. Thank you for an excellent post.

  10. Money Reasons says

    why do you think people feel it’s OK to spend other people’s money as they wish?

    In the government’s case, I believe that they think it’s their job to spend the money… and in may ways they are right. The problem is they aren’t spending it trying to get the best value as Milton Friedman explains in the video.

    I think we need to get our fiscal programs back in the black, however, that would take years… And if an official is voted in office and does nothing except try to get finances in order, some news station, newspaper, or whatever will identify that government official (or president) as a lame duck…

    Kind of sad really… We are our own worse enemy when it comes to finances.

  11. Greg McFarlane says

    I’m fairly certain that Dr. Friedman would have argued that providing defense and roads are two of the few legitimate functions of government: a private road system (or defense force) has too much potential for free riders who’d benefit from the product without ever paying for it.

    But health care? That’s the ultimate personal service. The only one who benefits from my fixed broken ankle is me. Same deal with buying a vehicle from GM or Chrysler. When our politicians decide that almost any personal economic benefit constitutes a “right”, there’s no limit to what they’ll judge appropriate for the greater good.

  12. Instant payday loans says

    Nice tips. By spending their own money on themselves, people really watch out what thay are doing, and try to get the most for their money and by spending someone else’s money on someone else, they are concerned about what they will actually get.

  13. Xerographica says

    Taxpayers should be allowed to directly allocate their taxes! Forcing taxpayers to consider the opportunity costs of their tax allocation decisions is the only way to guarantee the best possible use of public funds.

    People usually respond to this idea with concern that some “important” government organization would be underfunded. They don’t understand that their concerns just indicate how they themselves would allocate their own taxes if given the opportunity. I’m sure if more people actually understood how the invisible hand works that this idea would have already been implemented.

    http://pragmatarianism.blogspot.com/2011/11/opportunity-cost-of-public-goods.html

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