What Is The GIT?

Do you make a substantial amount of money but feel like you’re not getting ahead? Unfortunately, you may have fallen into The Gross Income Trap (GIT). The gross income trap is thinking, behaving, spending, and living a lifestyle as if your Gross Income is your Net Income. Gross income is our income before taxes and deductions. Net income, also known as take-home pay, is the result of having taxes and deductions taken out of our gross income. The GIT can feel like an invincible force preventing you from achieving your financial goals. Here we will discuss factors that contribute to the gross income trap, the negative impact of it, and ways to avoid it.

WHAT LEADS TO THE GIT?

Our Everyday Vernacular

There are several factors that can lead a person to fall into The GIT; one of them is our everyday conversations. When individuals speak about income, they usually refer to the gross amount and not net income. It is not unusual to hear a person say they made $50,000 last year or they are hoping to make $80,000 in the near future. These conversations are often had without any thought of taxes and deductions. When taxes do come up in a conversation, they are usually referred to separately from their income. For example, a person may speak of their dislike for taxes without referring directly to how much taxes they do pay and how much their gross income has decreased. As to say they are aware of their tax obligations, but they still perceive their income as whole. Net income rarely dominates everyday conversations, unless a person is discussing their pay stub. Also, in many cases, a person’s pay stub can be the source of confusion. This is due to varying deductions listed on a person’s pay stub along with federal and state taxes or, in some cases, a lack of state taxes depending on the state.

The Media

We are constantly exposed to media: from our phones when we wake up, to our radios when we drive, and to billboards and posters when we are outside. In many cases, when income is being discussed in the media, it is commonly focused on gross income. For example, when the contract of an athlete or a media personality is discussed, it is usually mentioned in terms of gross income. You would see headlines such as “Chicago Bears Sign Rookie Running Back To A $30 Million Contract For Five Years!” This constant use of gross income with little to no mention of net income in our constant exposure to media has given us the impression that a person has the buying power of their entire gross income–which is not true. When income statistics are quoted in magazines, television news, and now social media, they are always quoted in gross income without any mention of net income. The emphasis on gross income in our media gives us a false impression that our buying power equates to our gross income.

Human Nature

Another factor that contributes to the GIT is our human nature. Humans naturally move towards experiences that bring positive feelings and repel away from experiences that bring negative feelings. High income is associated with positive feelings, and low income is associated with negative feelings. It feels much better to say I made $80,000 rather than $60,000–factoring in an average tax rate of 25%. (Numbers are not exact but are approximated.) In this example, the thing that is skewed is not the person’s income but their buying power. Their income is $80,000, but their buying power is $60,000. You can see the brewing danger of falling for the Gross Income Trap. They are not being dishonest by saying their income is $80,000, but saying $60,000 does not have the same emotional gratification as the former.

Simplicity

Simplicity is another bias of human beings that contributes to a person falling into the gross income trap. It is much simpler to refer to gross income than it is to refer to net income. When comparing the two, gross income is fixed while net income is a derivative of gross income. There are fewer steps when calculating gross income: wage rate multiplied by hours worked and the occasional bonuses, commission, and tips, depending on the type of work. In most cases, gross income is already nicely calculated and presented to us in an easily digestible form. While net income is based on a percentage of federal and state taxes, deductions, write-offs, and credits. This shifts the responsibility to the individual. This makes calculating net income much more complicated than the calculation of gross income. It is much simpler and easier to say I make $80,000 rather than $60,000 without doing the necessary calculation. To make the matter more complicated, the take-home pay that is presented on a person’s pay stub may not be a true reflection of their buying power, due to their tax responsibility come tax time. A person may find themself owing taxes or receiving a refund. With that said, net income does a better job of coming close to what a person’s true buying power is. Nevertheless, it is more challenging to derive for the individual. 

NOTE: Net income varies from person to person.

Not all gross incomes are created equally. Some gross incomes, even if they are the same amount, can lead to different net incomes. For example, two individuals may have the same gross income of $80,000 but have different net incomes due to different sources and individual deductions. This can lead to one individual having a lower average tax rate, leading to a higher net income. Which adds to the argument of why gross income is less complex to present in conversation and media than net income.

Associating Income With Self-Worth

In society, income is tied to self-worth, which is another factor that can cause a person to fall into the gross income trap. When a person’s self-worth is tied to their income, they are more inclined to favor and focus on the highest amount regardless of their real buying power. Referencing our examples of $80,000 gross income and $60,000 net income, a person may feel a higher sense of worth assuming the identity of an $80,000 gross income earner rather than a $60,000 net income earner. This can cause a person to spend more because they believe they make more than they actually do. In many cases, the more they spend, the better they feel about themselves. 

Our society also reinforces the connection between income and self-worth by attaching virtues such as intelligence, hard work, and honesty to results that lead to higher income. These factors create an atmosphere that makes focusing on gross income rather than net income effortless. Which leads us to think, believe, and act as if our gross income is our buying power.

NEGATIVE IMPACT OF THE GIT 

False Impression Of Buying Power

One of the major concerns of the gross income trap is that it will give a person a false sense of buying power. A person with a false sense of buying power will believe they can do and accomplish more financially than they actually can. Depending on the gap between their gross income and net income–considering our above example–that can be as much as $20,000. Such a gap will have a person spending as if they have access to the $20,000 that is deducted–which is not the case. This will have a negative effect on a person’s financial life.

Budgetary Issues

Being able to create and maintain a budget is an important part of achieving financial goals. The gross income trap will impact a person’s ability to create a realistic and functional budget. A person may find it difficult to create and stick to a budget because the numbers are not adding up. This will definitely be the case if a person starts their budget with gross income without estimating taxes and deductions. If everything is considered except taxes and deductions, it will be impossible to stick to the budget. This will give a person the impression that they do not make enough, which may not be the case.

Overspending

When a person has difficulties creating a functional budget due to the gross income trap, it often leads to overspending and not spending in a way a person intended. This leads us to an important question: how can a person overspend when the gross income trap causes them to overestimate their spending power? The answer is debt, in the form of credit cards and borrowing. Unfortunately, there are those that will fill the gap between the money they have and the lifestyle they want with debt. This will eventually lead to financial hardship if they do not spend within the means of their income.

Negative Self-Worth

Imagine a person working hard to achieve the income they desire, only to feel they are not getting ahead. They have achieved “six figures”–which is the current buzz phrase–only to live paycheck to paycheck. Associating your self-worth with your income will cause a blow to your self-esteem if the money you desire, if achieved, is unable to satisfy a lifestyle you think it should. They believe that because their gross income is $80,000, they can afford an $80,000 lifestyle, and in actuality, they can only afford a $60,000 lifestyle.

Unpaid Taxes

The chance of falling for The GIT is higher for higher-income individuals. This is due to a progressive tax system, which is used by many countries. A person that falls in the low-income bracket will not see much of a difference between net and gross income. While a high-income individual will see a vast difference between their net and gross income. Many types of entertainers, such as those that are performing artists, are examples of people that sometimes fall for the warped perception of their income. Musicians that are paid by promoters and venues are responsible for deducting taxes and paying the IRS. Instead, many new musicians find themselves owing the IRS during tax season. They are unable to pay because they spend most, if not all, of their income without setting any aside for taxes. They then realize that the income they were receiving all along for performing was their gross income. This puts the entertainer in a deep hole, which makes it difficult to climb out of during the next tax season. 

TIPS TO AVOID THE GIT

Focus On Net Income Vs. Gross Income

One of the actions a person can take to avoid falling for the gross income trap is to focus on their net income. Taking the time to focus on net income will give them an impression of their true spending power. After shifting their focus to their net income, they must understand how their own personal circumstances can impact their tax responsibilities come tax time. This is especially true of high-income individuals who will not receive a tax refund after they file. Focusing on net income and knowing your tax responsibility will give you a true understanding of your spending power, which will help you avoid the gross income trap.

Disassociate Self-Esteem From Income

It is difficult separating your self-worth from your income in a society that puts so much value on materialism. A lifestyle surrounded by purchases will give a person the impression that that is where their value lies. How much money a person makes does not entitle them to more respect, love, or admiration. Your income is only a measure of your labor cost and a sign of your purchasing power in an objectifying society. We may live in a society where wealth is exalted, but wealth is only an indication of purchasing power–not their self-worth. Living within your means will help individuals avoid the gross income trap.

FINAL THOUGHT

Gross income is income before taxes and deductions, and net income is income after taxes and deductions. Most individuals, especially those that fall into the gross income trap, do not have difficulties differentiating the two; they run into issues living a lifestyle as if their buying power is equivalent to their gross income. In many cases, debt is used to fill the gap that taxes and deductions create. This can lead to unmanageable debt and eventually financial ruin. It is in a person’s best interest to ensure that they do not fall for the gross income trap. Understanding that their buying power is associated with their net income and not their gross income will help them maintain a healthy financial life.