Wednesday, March 25, 2009

The Tax System - Explained With Beer

There is a lot of talk about "job creators" and "redistribution of wealth" and fair taxation lately. No, I am not an expert on taxation, but I tend to be a good student of the human condition, and I know one thing for sure, that while we are all created equal, we are NOT all endowed with equal gifts. Some of it is just luck, and some is hard work, but however it has been gained, there are differences in all of us and trying to 'make' us equal through taxation is just counter-intuitive. I believe the story below makes the most sense.
Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20."Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?'

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 ( 25% savings)..
The ninth now paid $14 instead of $18 ( 22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

"I only got a dollar out of the $20,"declared the sixth man. He pointed to the tenth man," but he got $10!"

"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"

"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

For those who understand, no explanation is needed.

For those who do not understand, no explanation is possible.


Anonymous said...

It's interesting that a professor of economics gives an example that is not accurate.

The publican drops the price of a round of beer to $80.00 yet he calculates each person's share to total $79.00! No self-respecting publican would cheat himself out of $1.00.

Also every time I go to a pub, we make sure that everyone buys a round, and the free-loaders would be sitting in the car-park! Pat Mulligan.

Profit Prophet said...

Ha, ha.. touche sir!!! Yes indeed...thnx Pat for the shrewd observation!

Jim Adcock said...

Another problem with the example - the contention about the wealthy getting a "bigger cut" ($10 reduction compared to a $1 reduction) is also an inaccurate representation of recent debates about the fairness of the way tax cuts have been distributed recently.

In reality, the recent "tax cuts for the rich" have been more like a $18 cut for the top guy, nothing for the bottom payers, and $.50 average cut each for 6-9. After the tax cut:

1-4 still pay nothing
5 pays $ .99 (saves a penny)
6 pays $ 2.75 (saves a quarter)
7 pays $ 6.50
8 pays $ 8.50
9 pays $13.24
10 pays $41

Missing from the example is that, to cut the price of the beer, the publican now uses smaller mugs (budget cuts). He also no longer supplies beer nuts, which the first four guys eat to make sure they get enough nutrition (their income is insufficient to meet their food needs).

Also missing - the fact tat 1-4 don't make enough to pay for a single beer every week anyway, and 10 could buy the pub (as well as the two down the street) each week. Ten is also the owner of the company, and sets the wages for the rest. And yet they are all working 40 hours a week, just the same (except the first guy, he is about 75% unemployed).

To top it off, while the story uses beer to ostensibly make taxation "easier to understand" it makes the outcome of taxes appear to be optional "disposable income" rather than the essential services we all use every day - roads and bridges, epidemic research and prevention, military, police, fire, border patrol, food inspection, pollution prevention, education, and thousands of other services.

The story is filled with spurious logic as well as bad math and missing facts and is a poor description of how things actually work.

Dan Kirkwood said...

Sorry Jim, but I guess that you are the living proof of "For those who understand, no explanation is needed.

For those who do not understand, no explanation is possible."

I believe the key point is that in graduated taxation, a class of people are exploited because they have more money, and then when a break comes they get a larger share of the break but still pay a substantial percent more than others. I don't see poor people hiring people. And when rich people get fed up with it and decide to go elsewhere, they leave poverty behind them from all of the people they have been supporting.

Most wealthy people are not upset over the system we live in, just tired of being demonized for being wealthy!

Thank goodness they don't do that for sales tax! Can you image if anytime you purchased something, you had to prove your income and that would be the basis of your sales tax? Humm, maybe I should not give politicians any ideas!

Profit Prophet said...

Jim thank you so much for your comment and insight...but did you know that both the IRS and the FED where created at the same time? The REAL evil in the world is that we pay a tax (yes a tax) on money that our government should print for free to a private bank...yes, the Federal Reserve is a PRIVATE bank. So, no matter how you feel about taxation (left or right) we seem to never look at the causation of it.. just saying..

Profit Prophet said...

Oh my Dan...that would be... horrible <3