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Does Government policy and action affect personal finance?

Published:Sunday | December 28, 2014 | 12:00 AM

Oran Hall, Personal Financial Advisor

The policies governments make and the action they take affect personal finances favourably and unfavourably, so it is important to pay attention to them to be able to respond in ways which can reduce their impact or yield the positive results which they promise.

Many of these policies and actions can have long-term and even lifelong consequences. We can recall how the high interest rate policy of two decades ago contributed to the financial sector collapse then. While individuals who had significant cash resources were able to earn significant levels of interest income, the effect on businesses and on persons who borrowed from financial institutions was catastrophic and many are suffering for it to this day.

This suggests that government policy and action have a direct effect on individuals, but they also have an indirect effect on individuals when, for example, they affect business because of the consequences for job creation or the maintenance of employment levels and because of the effect on profitability and the payment of dividends. When the additional expense of higher taxes is passed on to consumers, this reduces their ability to purchase the same levels of goods and services or causes a reduction in the levels of savings if consumption levels are maintained.

When the income tax threshold increases to $557,332 on January 1, 2015, it will reduce the effective tax rate of persons who pay income tax. If inflation is not contained, this will likely erode the benefits to taxpayers, but nonetheless, there will be more money in their hands. How should taxpayers respond? Ideally, this extra disposable income should be saved, but I would not be surprised if some argue that this is not an ideal world.

Taxes tend to increase rather than decrease. When they increase, they reduce the disposable income of taxpayers and even persons who do not earn an income in the case of taxes such as the general consumption tax. To maintain the level of their savings, individuals would need to reduce their level of consumption and thus their standard of living. Reducing the level of consumption can be good for some persons considering how loosely they spend and the low priority they place on savings.

The reality of low interest rates today is having a harrowing effect on persons, particularly pensioners who depend on interest income to meet a portion of their living expenses. Thus, the debt exchanges of the past with lower rates of interest and longer maturity terms have not been good news for the public. On the other hand, to the extent that the cost of borrowing has fallen, it is easier to service debt.

When government implements a wage freeze for its employees, it helps to save public sector jobs, but its employees pay a price. Inflation erodes their purchasing power. The effects of this action are wider for those who are members of contributory pension plans, especially if they are members of defined contribution plans. When income does not increase, pension contributions do not increase, thus reducing the prospects for better pensions in the future. Further, when combined with lower interest rates and the consequent lower returns on pension funds, pension fund members face the prospect of lower pensions in the future.

Yet, government does take action to give citizens a better chance to have a retirement income. Note, for example, government policy regarding pensions which provide for the portion of the employee's salary that goes into the pension fund to be deducted for that purpose without being taxed and for income earned on such funds not to be taxed then, but for taxes to be paid when a pension is being paid from a statutory pension scheme or an approved superannuation fund if it exceeds the income tax threshold plus the $80,000 exemption for pensioners and the $80,000 age exemption for persons aged 65 and over.

How government manages matters such as inflation and the exchange rate also has implications for personal finances. High inflation reduces purchasing power and the ability to save. A low exchange rate contributes to high inflation, but benefits persons who receive foreign currency, and there are many Jamaicans who can count on their regular flow of remittances.

Government policies which affect access to education and health care and the cost thereof also bear on personal finances, not just in the short term, but in the long term. They determine the extent to which persons must find the financial resources to meet those expenses today and the extent to which they will continue to meet today's expenses tomorrow and beyond when they incur debt.

What government does matters. Its policies can affect the levels of savings and investment, borrowing, spending, income from all sources, all types of insurance, estate planning, the retirement age and retirement income. Changes brought about by government policy and action can also affect goal setting and budgeting.

It is important to follow what the Government does as it affects personal decision-making and thus personal financial matters. This is particularly necessary considering that governments change policies when they deem it necessary. Every resident of the country needs to prepare to take action to reduce the effects of unfavourable policies and actions and to reap the benefits of those that are favourable.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Planning', offers personal financial planning advice and counsel. Email