Chapter 6 of TAX Your Imagination!
6. What is the Cost of Living?
Changes to the Cost of Living wreak havoc with budgets. If advance planning could fix expenses and revenues, then the self-fulfilling prophesy that a budget attempts would be easily accomplished. Economics is the study of success and failure because budget expectations, formalized or not, fall victim to inflationary pressures.
The Cost of Living can be expressed as Revenue over Expenses: R/E=CL. When R/E is greater than 1, there is a budget surplus and a rising Standard of Living. When R/E is a fraction, there is a budget shortfall and a declining Standard of Living. Strictly speaking, however, E=CL. Expenses are the Cost of Living. R (revenue) is how you pay for it.
The Cost of Living is a mathematical formula with political or social consequences. It is the divide between the rich and the poor, getting ahead or falling behind, the good times and the tough times. It concerns the ability to live within ones means and the quality of life. It is psychological, mathematical and material. For some, happiness is getting what they want, whereas for others, it is wanting what they have gotten. Life can be a perpetual hunger or a state of contentment, regardless of the material circumstances.
The Cost of Living (CL) is intimately related to the Standard of Living (SL). One of the odd things about this relationship is that there can be an inverse correlation to the budget goal. For example, living beyond the budget (carrying a deficit by borrowing) can increase the Standard of Living. To adapt the old cliche, one may not be a millionaire, but one can live like one by borrowing and then spending a million dollars.
Most economic theory claims that increased revenue increases the Standard of Living. This is the motivation behind "priming the pump,' "stimulus packages,' and getting a professional degree. Materially and emotionally, there is an expectation that bigger numbers mean more happiness. Yet, many with fame and fortune are miserable, as the tabloids are quick to document. A greater revenue ensures that one can spend more, but happiness cannot be easily quantified. Statistics imply an increase in material wealth with an increase in revenue. The higher the income, the more one can purchase. Unfortunately, however, the cost of what one purchases changes over time, too. A small and steady increase in revenue may or may not keep pace with inflation or fixed expenses. Larger revenue does not guarantee that you can purchase more, only that you will spend more.
When analyzing the Cost of Living, the amount of dollars is secondary. What matters more is the ratio between revenue and expense. The ratio indicates whether one is 1) breaking even, 2) flush with cash, or 3) losing money. The spending and revenue can vary wildly from individual to individual or from organization to organization, but their comfort or discomfort with money is based on ratios. Everyone has a unique mathematical relationship with money, and it is driven by ratios. Being unable to meet a mortgage payment is stressful, regardless of the size of the bill or value of the home. Failed budgets are painful.
When expenses are greater than revenue, that person is living fractionally. For example, $50,000 in expenses, but only $40,000 in revenue: 40000/50000 = 4/5, which is .8, or less than 1. Any fraction is a negative ratio. When revenues are greater than expenses, that person is living at or above 1. For example, $40,000 in expenses with $50,000 in revenue. 50000/40000 = 5/4, which is greater than one: 1.25. Any whole number is a positive ratio. A negative ratio is only possible with borrowing.
The Cost of Living Ratio by Steve Consilvio
For someone who is living fractionally, or nominally at a whole number 1, their expenses are always tight with their revenue. They have to be careful from day to day, and change their spending, eating and travel habits based on cash flow. They may splurge when feeling flush, and then contract as necessary. For them, inflation and unanticipated expenses are a perpetual challenge. The more that is spent on any one object, then the less money is available to spend on another product. It is a zero-sum-game existence, especially when credit is not available. This lifestyle represents the majority of people and businesses. While some people have amassed huge hoards of wealth, or inherited wealth, few people live without any concern for money. Those who have become wealthy usually struggled with a fractional ratio at some point in their life. The struggle of businesses and for personal advancement share a similar fate.
For those living fractionally, budget adjustments are a constant way of life, not a formalized procedure. If the cost of gasoline rises, then they may change their food spending to compensate. Businesses and individuals, in general, respond to inflationary pressures better than governments. Governments fix their budgets and are slow to deviate from them. Administrators are sure to spend their budgets for fear they will get cut in the one that follows. A lot of political wrangling stems from the fact that the government, by design, sets a long-term budget that locks itself into a fractional position. While the budget is passed at 1, it almost always includes a component of borrowing, and assumptions that will not be true. When spending equals what was earned, there is a financial angst. Inflation is constantly nipping at their heels.
The challenge is always to get revenue to be greater than expenses. Fiscal changes can be quite significant, negatively and positively, but yesterday is always a difficult baseline to maintain today. Pressure does not stop once one gets ahead.
Ability to Respond to Flucuations by Steve Consilvio
Everyone has fixed expenses that they cannot change quickly or easily. This generates the tension between the Cost of Living and the Standard of Living. Using debt as a solution to maintain a Standard of Living has brought both the great and small to their knees. Those with a higher Standard of Living can be poorer than those with a lower Standard of Living, if they are living on borrowed money. The seemingly rich can be trapped in a negative ratio, having borrowed more than can ever be repaid. This comes to light in bankruptcy proceedings where businesses or individuals are millions and billions of dollars in debt. Their wealth was all borrowed. Similarly, America is the richest nation in the world by being the world's largest debtor.
Standard of Living Pressure by Steve Consilvio