Charging Your Way to Tax-Free Living?

I came across an interesting theory on money and credit lately. Of course, it was posted on the internet, a good sign that it should receive some scrutiny...

A guy was thoroughly disgusted with the overall reliance and heavy-use of credit cards among Americans, but he said he knew why that was. After all, he said, the use of credit cards is equivalent to making tax-free money since money from loans is not taxed as earned income is.

[Be forewarned, there's lots of math ahead.]

His example was a person, who makes $30,000 per year could have the same lifestyle as another person making much more (in the $50's) just because the one making $30,000 and charging another, say, $15,000 wasn't having to pay the many taxes (say, 30%, he stated) that come out of one's paycheck on those credit card charges.

It's an interesting theory, one that I'd like to put pen to paper on, so here goes:

For now, let's put aside the fact that you'll have to pay it back someday. If your argument is that the amount charged is "tax-free" income, then only the $15,000 could be used with the 30% tax "inflation" factor shown as (X-0.3X) = $15,000 => 0.7X = $15,000 => X=$21,429 rounded. This amount, in addition to the $30,000 actual salary, would be the equivalent to a person making $51,429, who had to pay taxes on all of it at the said 30% rate.

To get to a point where this fictional person is "making" (or at least enjoying the lifestyle) of twice the amount of his/her actual earnings -- or $60,000 -- you would have to charge $42,857 on the card or cards, which is figured as follows: ($30,000 + (0.7X)) = $60,000 => subtract $30,000 from each side of the equation and => 0.7X = 30,000 => divide both sides by 0.7 => $42,857.

But, alas, you have to pay it back in reality:

So, since most credit cards charge a minimum monthly payment of 1 to 2% of the balance, this would equate to a $429 to $858 per month bill, depending on the card company. This would put this person, who makes $30,000 per year gross in actual compensation, in an immediate 17% to 34% debt-to-income ratio without any other outstanding debt considered.

Most banks, do not want to see any more than a 36% debt-to-income ratio when all debts are considered, although some will go to 40% in special circumstances. Therefore, you could charge that much is one year ($42,857), provided a card company would give a person 1.43 X's his/her annual salary in available credit; however, you'd only last one year charging things at this rate because of creating such a high debt-to-income ratio.

Of course, at that point, you'd be paying back debt on the card(s) for the rest of your life -- or at least 100 months paying even the $858 per month at a 19% interest rate. So, I'm not sure the "tax-free living" theory is exactly worth it, but this little run-through certainly helps to reinforce his disgust about the heavy-use of credit in America today.

It also makes me thankful that HP makes such a great financial calculator to test these theories without much work.