What Does Financial Freedom Mean?
by Michael S. Rozeff
by Michael S. Rozeff
There are entire books, brochures, and websites devoted to financial freedom. What they talk about is how to attain a big amount of wealth so that you are "free" to do what you want. They are talking about attaining financial wherewithal, financial means, or financial power.
This use of the word "free" is common. I don't think it will be easily altered. Unfortunately, this usage hinders and misleads us when carried over to political discussion. If we misuse the word freedom to mean absence of resource constraint rather than absence of offensive coercion, we will be led down the garden path to socialism.
To understand what is involved, consider Robinson Crusoe, alone on his island. He is poor, but he is free. He is free even though Nature provides him rather meager resources. He is free to choose and act. He has this freedom of choice because there is no other person to compel him to choose otherwise. However, his opportunities are rather limited. He can only select courses of action from the limited menu of choices that he knows are attainable to him.
If men intentionally place Crusoe on this island as a kind of prison, we say that he has lost freedom. If an accident, a shipwreck, brings him to the island, we do not say that he has lost freedom.
If we say that accidents or the environment or Nature make and unmake freedom, then we are personifying various forces and events. We all anthropomorphize, and most literature does. Nature is not a person, however, and to think of it as a person erases the distinction between what men do and what befalls us through no design of men. It converts Nature into a person that dispenses justice and injustice. Not far away from this conception lies Rawlsian justice. Then come vain and offensively coercive attempts to equalize resources and human beings.
Crusoe's menu is constrained or grounded in the realities of his situation. Suppose that an ocean liner arrives at the island one day. The captain tells Crusoe he will transport him to Wales for 12 large pearls, but Crusoe has no pearls. Our financial freedom writers say that Crusoe lacks financial freedom because he doesn't have the means to purchase a trip. They say he is not "free" to travel. What they mean is that he is constrained by a lack of resources.
If we use the word free to mean unconstrained by a lack of resources and unfree to mean lacking resources, then no one is ever free because everyone is constrained by a lack of resources. This use robs the word free of its primary meaning. A free person can choose from a set of actions, without compulsion from others and given the resources at his disposal.
Freedom is defined in terms of choice at an instant, given the resources you have. Freedom does not rise and fall with your resources or wealth.
Crusoe cannot choose to take a plane to Pasadena. He cannot talk with anyone. He cannot find a mate. He cannot find a doctor. These are unavailable opportunities. Even if he had a million pearls, he cannot achieve these values. This may make him worse off but it doesn't decrease his freedom. A cave man who did what he pleased without being forced to by someone else is no less free than someone today in the same position (if such a person exists.)
A poor man who cannot afford a meal at a fancy restaurant, or pay for a surgeon, or pay for his son to attend an Ivy League college is in a similar position. Neither Crusoe nor the poor man lack freedom. They either cannot locate certain opportunities or they cannot select from those opportunities that are offered.
The socialist tells us that Crusoe and the poor man are not free as long as they do not possess a menu of items that the socialist designates. The socialist equates freedom with the existence of a designated menu of opportunities and the means to choose among them. Again the socialist robs the term freedom of its central meaning. He replaces it by a set of material objectives. To him, freedom = wealth.
Similarly, the purveyors of financial freedom have the mistaken notion that the constraints imposed by nature or one's resources or one's knowledge or one's means reduce one's freedom. These types of constraints reduce one's menu of choices or one's conceived menu of choices, but they do not reduce one's freedom. Only men can reduce other men's freedom.
Limitations of knowledge, wealth, means, and opportunities and limitations imposed by nature do not restrict freedom. They restrict what one can attain and what one can do. They can restrict both one's achievable ends and one's achievable means. Crusoe cannot buy a Cadillac, and he cannot make one.
Our financial writers will conclude that Crusoe is not free to build a Cadillac, or tell me that I am not free to play in the NBA. We are pretty much stuck with this aspect of the language. If I argue that Crusoe is not "not free to build a Cadillac," then it may seem that I am maintaining that he is free to build a Cadillac. And you may find that conclusion implausible.
There are two responses. First, I can try to persuade you that "not free to build a Cadillac" is more exactly replaced by not spontaneously able or not spontaneously within his power or not spontaneously within his means to build a Cadillac. If "not free" is a false description, it does not imply that free is a true description. For example, if you say that "not blue" describes a red house, then not "not blue" or blue is not necessarily a correct description either.
Second, I can logically maintain that Crusoe is free to build a Cadillac. This means no one compels him not to try. He is also free to book a passage to Mars. He will simply discover that he can't do these things. However, as we shall see in the next example, going this route is too counterintuitive to persuade anyone.
We clearly should distinguish spontaneous or natural limitations and constraints from those induced by the aggressions or offensive coercions of people. Suppose that one is inside a cave and the entrance collapses due to a mudslide. One is not able to leave. We will hear it said that one is not free to leave, and I doubt that this convenient expression will soon disappear from the language. However, we should demand that political writers avoid the related errors of logic regarding the meaning of freedom by understanding that this person is imprisoned by a spontaneous and natural physical constraint.
Suppose instead that men outside the cave confine you by building a wall across the entrance. Again you are not free to leave. However, now your freedom has been curtailed by the offensive coercion of other people.
I can yell out to you that you are free to leave when a mudslide blocks the entrance, meaning you can try and no one will stop you from trying. When you try to walk out, you can't. You will wonder if I have lost my mind. I am afraid that the use of the word free to mean unconstrained is so ingrained in the language that we simply must put up with having to dispel the consequent confusions that often arise. Even in science we find this use of free. In chemistry there are free radicals and free electrons that move around without the usual bonding.
You will now understand me when I say that financial freedom doesn't mean having a lot of money. It means being able to keep whatever income you earn, small or big, without someone else taking it away from you. It means the freedom to invest or spend it any way you want to. Freedom means the right to keep and use what is rightfully yours, and what is rightfully yours is what no one else has a valid claim to.
Suppose you lived in a country with no taxes, but you made only $500 a month. You'd be very constrained in what you could buy, but if no one compelled your choices, you'd be free. Although you might think that your freedom wasn't worth much, you'd be better off than if you made $500 a month and the State ordered you how and when to spend it. Freedom isn't wealth, but, no matter how poor or rich you are, you are better off with freedom than without it because you can make your own choices.
Keeping all your income means paying zero taxes. Zero, because taxes are forced from you, not taken via a valid claim. When the State's tax collectors take away your income, they violate your right to what is yours. You earned your income. The tax collectors didn't. Freedom means paying zero taxes.
The more taxes you pay, the less choice you have. Since taxes are compelled by other people, your freedom is reduced. If a robber stole your paycheck, we'd say the same thing. Your freedom was infringed. But if a wind blew half your money down a storm drain, we'd say you were unlucky or careless.
Majority votes for Congressmen or by Congressmen do not create valid claims on your income, because there is no logical or valid way for any number of other folks to show that they have a right to take away from you what you have earned.
If you agreed in advance to abide by whatever the majority ruled, then the majority would have a valid claim. Show me someone who has signed such an agreement, please. If you show me such a person, I will show you a fool. If you did sign such an agreement, you'd be placing your life in the hands of others. You'd be running the risk that they make you a slave.
Freedom means not being forced to pay income taxes, withholding taxes, social security taxes, medicare taxes, medicaid taxes, unemployment insurance taxes, capital gains taxes, gift taxes, estate taxes, plus a bevy of other taxes like gasoline taxes and sales taxes. That takes us back to the year 1790 or even 1890 or even 1910.
You probably do not want to go back to 1790, and neither do I. But don't confuse today's taxes with whatever well-being you possess today as compared with yesteryear. The proper comparison is between today with taxes and today without taxes. A great many of us prefer today without taxes to today with taxes.
Over many years, freedom fell as bureaucrats, officials, Congressmen and Presidents assumed power over income, over education, over health, over defense, over trade, over communications, over transportation, over money, over the bodies of young men, over elections, and over much else. While freedom fell, some gained power and wealth and some of us were given back some of what was taken away. Pay the barker $1.00 to shoot rabbits and get back an occasional trinket worth $0.25.
Freedom fell as taxes rose. Freedom fell as regulation rose. Freedom fell as each individual's personal control over his own life fell. The more Acts that Congress passed, the more that freedom fell.
Generations of Americans watched, listened, believed, voted, and submitted. They lost freedom. Some are unaware of the extent of their own slavery. They assume that their condition today of slavery is par for the course. Only a hundred years ago, it wasn't.
Many find themselves hamstrung, wondering how to get back what has been lost. There are no pat answers that I know of.
The second part of financial freedom is investing whatever we want, when we want, where we want, and with no worry about taxes or other burdensome rules. At present, our masters allow us to keep some money and invest. At that point, they tie us up, box us up, throw us around, and take away even more money if we make a return on our investment.
In 1981, our masters began to let us invest and defer taxes until retirement via the 401(k) plan. They let us! As if the money were theirs to begin with.
The 401(k) was a big improvement over what we had before, which was that we had to invest after-tax dollars and then pay taxes whenever we received income or realized a capital gain.
Why did they throw us this bone? It wasn't because millions of Francisca and Chico Americans demanded it. Large business firms favored it so that they could get rid of their defined benefit pension plans. The investment industry favored it because of the greater amounts of money it could manage. Corporations favored it because it would bring in more investment in bonds and stocks. The federal government favored it because it would receive a large share of that money via investments in debt.
Reagan favored it, an important political fact. If Republicans could be identified with this plan, they might get more votes. The tax-exemption feature of the 401(k) makes it a competitor to the Social Security program. Maybe voters would thank Republicans for this goodie. So the 401(k) came into being.
It's a shame that in all the years since, the law wasn't changed to allow workers to opt out of the Social Security program. They could have saved their money in 401(k) programs instead. Opting out of Social Security would have increased their financial freedom.
Now there are over 40 million people with 401(k) accounts. To like things uncomplicated and to dislike things bureaucratic are sound instincts. The 401(k) account is complex and rule-bound, and the rules keep changing. You can't withdraw money before a certain age. You must pay taxes on what you withdraw. You must put up with your employer's plan, and on and on. Furthermore, Congress has added on new sorts of similar accounts like Roth IRAs. In 2001, Congress allowed the self-employed and small businesses with no employees to start 401(k) plans.
Financial freedom would be so much better and simpler.
What is that freedom? Simple. There will be no taxes on dividends, interest, and capital gains. All investments are tax-free. Take your money out whenever you want to and pay no taxes. Shift investments from one place to another and not have to worry about rollovers, penalties, or any other nonsense. Investments includes all forms of debt, all forms of stock, all options, all real estate, all commodities including gold, all art, and all collectibles. If I've forgotten an important category, by all means add it on.
How pitiful to see grown men and women sweating over the arcane details of the government's various plans, calling radio talk shows to ask intricate questions, searching websites for answers, and finally paying an investment professional to help them figure out what to do. How pitiful that they accept this as the normal state of affairs.
The actual asset allocation decision is so important and so difficult that that's where the brain power should be focused, not on unnecessary details whose importance exists only because the tax laws make them important.
Financial freedom has other big slices to it. One of them is money itself. Another is financial markets and institutions such as banks and insurance companies. If these were free, the financial world might look quite different than it does today.
For the time being, 401(k) holders of the world, unite! There are 40 million of you. Demand your financial freedom. Demand an end to all taxes on all investments. Demand full control over your financial investments. Demand that 401(k) accounts be converted into your non-taxable property to be done with as you want when you want it.
December 10, 2005
Michael S. Rozeff [send him mail] is the Louis M. Jacobs Professor of Finance at University at Buffalo.
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