Under current state law, you are probably making an involuntary loan to the State of Colorado.
All businesses with employees in Colorado are required to withhold taxes from their employees’ paychecks. Withholding wasn’t even invented until World War II, and one of its inventors, Milton Friedman, has said that “it’s a great mistake for peacetime.”
House Bill 1087 would end involuntary withholding for the State of Colorado and allow you, rather than the state, to earn interest on the money that you will eventually owe in tax.
Involuntary withholding benefits state government, and tax-and-spend politicians, much more than taxpayers. You never see the money that is involuntary withheld, so you tend to underestimate the amount of tax extracted from you.
In fiscal year 2009, Colorado refunded about $886 million to individual income tax payers. On average, everyone who filed a return made the state a $544 interest free loan.
The tax and spenders will also say that withholding doesn’t matter because the lost interest on $544 is so small. Plus, the interest free withholding loans make up just 4 percent of the roughly $20.4 billion that the state collected in 2008. They will also argue that without that 4 percent from involuntary withholding loans, taxes would have to be raised to fund the essential activities of state government.
In the real world, 4 percent of the state budget is a lot of money. According to the 2008 State Taxpayer Accountability Report, 4 percent of the state’s budget would have been enough to fund the Department of Corrections, the Governor’s Office and the Legislature.
Enough would have been left over to provide tuition, fees, room and board to 550 students at the University of Colorado.
How much could you save if you didn’t have to make an involuntary withholding loan? The 2009 Colorado withholding tables show that a married person who has 2 deductions and is paid $4,000 a month has to pay $129 in withholding.
The Bankrate.com Simple Savings calculator shows that depositing $100 to start a savings account with a rate of 3 percent compounded monthly (a more normal interest rate than available at present) and then depositing $129 in it every month for 12 months would let you pay 12 times the withheld amount at the end of 12 months with $21.50 left over.
Twenty-one dollars may not be enough to defray the new car tax, but in today’s economic environment, every little bit helps. Rather than simply letting the state confiscate that $21.50, you might prefer to really stimulate the economy by taking a date to the movies, buying cookies for the school cookie fund, getting a haircut or making the co-pay on a long deferred doctor visit.
The ability to direct withholding into temporary savings is even more valuable in the event of an unexpected expense, especially if you would otherwise have to borrow at credit card interest rates of 15 percent or more. Borrowing $500 to pay for an unexpected care repair and paying it off in 6 months would require payments of $87.02 a month for a total cost of $522.12.
The interest lost from taking the money out of withholding savings and paying yourself back would be less than $8.
If we really want to get serious about a long-term strategy for reducing government spending, getting rid of involuntary withholding should be part of the equation.
Linda Gorman is a director of the Health Care Policy Center at the Independence Institute, a free-market think tank in Golden.