Economics, taxes, tax cuts, and politicians talking about all these things can be confusing. A friend of mine sent me a perfect example today to illustrate these concepts. It’s simple and something to which many people can relate. The sad thing is that too many people drink for free, and still others are paid to drink!
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.
David R. Kamerschen, Ph.D.
Professor of Economics
University of Georgia
For those who understand, no explanation is needed. For those who do not understand, no explanation is possible.
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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.
The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day in 2002, the bar owner, a devout republican, believing in trickle down economics, tried to spur business more by reducing the price of the beers. ‘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 only problem was that the cost to run the bar remained the same, the bar owner was now in deficit spending.
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 paid $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. (Wow! ask yourself if we experienced any riots or a revolution during 2002-2007 when the tax cuts took effect)
The bar owner, did entice some additional business in his bar, but not nearly enough to stop his swimming in debt. So he decided to raise rates on his customers. But how would he do this?? He pondered the question.
He entertained the idea of a flat rate for all of the beers. Everyone could pay $9. This would recover 10% of the lost revenue from the pre 2002 prices and he could more readily operate the bar without the losses. He did after all attract some more business due to the lower rates. He performed some more examination and determined that certainly six of the men would not be able to pay for the beers. The seventh man who was paying $5 might be able to pay nearly double for the beer. The remaining three men would certainly come back since they were paying much less for their beers. But even counting up to four men attending, he would only get $36 at the $9 flat rate. He would have less expenses for the beer consumed, but it still would not make up for his fixed expenses in running the bar.
The bar owner still liked the idea of flat rates, he was after all a devout republican. He cranked the numbers. A $10 beer would not help much, he might be able to increase the revenue to $40, but that last man who was paying nearly double may drop out and his revenue be reduced to $30. What about a $20 beer, now he could only sell to the top two men — one with a hefty increase from $14 to $20. The flat price for beers would not work in any manner.
So the bar owner went back to the progressive pricing system that had seemed to work well in the past. He decided to keep the prices the same for the lowest paying customers, but to recover his expenses from the highest paying customers, still at a lower rate than the pre 2002 pricing.
The first five men (the poorest) still paid nothing.
The sixth would still pay $2 (33% savings from the pre 2002 prices).
The seventh would still pay $5 (28% savings from the pre 2002 prices).
The eighth would still pay $9 (25% savings from the pre 2002 prices).
The ninth would now pay $16. More than he had but still an 11% savings from 2002.
The tenth man (the richest) would now pay $58, about the same as the original $59, but still lower.
The bar owner was amazed at the amount of complaining from the two richest men. He had heard all of the complaining from the poorer men about unfairness of the system when the prices were reduced. But these complaints paled in comparison to the complaints and threats received from the two richest men. The two richest men complained about the cost increases when in actuality they were still cost decreases from the pre 2002 levels). They complained even louder about their costs in comparison to the poorer men. The bar owner tried to explain that he just could not operate at the lower price levels, but to no avail. The two richest men even threatened to not come back to the bar. You see, they had become accustomed to paying less for their beers and spending money elsewhere.
For a time they even left the bar and went to less expensive bars (some of them even in Bermuda). But they soon realized that the original bar was located in a safe area of town, had good roads to get to the bar, the beer was clear and pure (there were scares of melamine tainting at other bars), the utilities were constantly on and running, and the air was not polluted.
The two rich men came back to the bar for these reasons and decided that you have to actually pay for a quality bar.
And that, boys and girls, journalists and college professors, is how anyone can spin a story rather than discuss the facts about a policy. 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. But then they find out that the other bars are not as good. All bars have their problems but this is still the best one around.
The wealthier you are the most benefit you derive from government. In addition to protecting us physically from foreign and domestic application of force, some of the most important, fundamental functions of government are to protect property rights and enforce contracts. In other words, government provides the legal infrastructure required for a functioning economy. It is certainly equitable to expect everyone to pay for that which they benefit, so it makes sense for the rich to pay more taxes.
That being the case, it is also important that the law treat everyone equally; black, white, gay, straight, rich, or poor, we are all Americans. A flax rate of taxation, levied equally upon all adults (whether citizens or not, everyone living here derives benefit from stable government) is sufficient to ensure everyone pays an appropriate share. Someone who earns $10K a year pays far less taxes than someone making $1M if both are assessed an equal tax rate. And that’s only if we consider taxing income, which is counter productive. Why tax productive economic activities?
The purpose of taxation is to raise revenues, so we ought to look for the most efficient alternative. Graduated taxes assessed on income hinder growth and persecute those on the upper end of the income spectrum. To conceive that these persecuted classes baseline their expectations upon periods in which they were even more persecuted (paying far higher taxes) and then dismissing their complaints is not fair. Yes, tax rates were far higher at points in our history, but that does not mean they were justified then or now. People have a right to expect equal treatment by the law and to keep that which they earn. Making claims on other peoples’ property solely because we happen to inhabit the same political jurisdiction does not make it right.
Next, we must question the magnitude of government expenditures. Our noble politicians can seize the entire national product (GDP) and spend it for us, but does that provide for a better society? Government already spends nearly $3 trillion annually, about 20% of GDP. It is perfectly legitimate to question the size of this outlay and the associated tax structure required to sustain the spending binge. For some citizens to demand others pay for this massive bill and then to shut up and stop complaining is outright bullying. It is possible to lower expenditures and taxes.
Rob:
“The wealthier you are the most benefit you derive from government.”
you are VERY VERY VERY wrong!
http://www.taxfoundation.org/files/sr151.pdf
-page 9- -figure 6-
dont make a claim unless you can back it.
Mac,
Great chart and reference. I recommend everyone reading this review the above link. It shows that the more your earn, the more taxes you pay, and the fewer subsidies you receive from government. This is absolutely true and the exact figures are staggering.
That’s not what I was talking about by “deriving benefit from government.” I was referring to the general economic and social benefits of living in a stable, governed society that has rule of law and a judicial system. Specifically, I meant to call out that the more property you own the more you benefit from safeguards on property rights. Similarly, the more business you transact, the greater your benefit from contract enforcement. These are the pillars of government’s functionality and justify wealthier people shouldering a larger share of the tax burden.
Ideally, everyone would pay for every benefit they derive from government. There is a potentially quantifiable premium that can be tagged onto property values derived solely from laws that safeguard ownership. Without this each property would be discounted in value to reflect unknown risks. An ideal system of taxation would have transparency into this value and levy it directly upon those who derive benefit. This is not meant to be discriminating in any fashion. I am not saying that only certain classes should pay taxes. Rather, everyone benefits in some way from the same general government functions, and each should pay proportionately.
It would be difficult to say that a teenager with no real property benefits equally from property laws compared to Donald Trump or Warren Buffett. So it would not make sense for them all to shoulder the same tax burden.
That being said, please reread my article, since the main premise was that taxes should be levied equally as far as percentages are concerned. I am opposed to discriminatory class warfare.
Utter rubbish.
The “great chart and reference” is made up gibberish. The paper talks about benefits people receive from the government — “public housing, roads, schools, the Postal Service, unemployment compensation, Medicaid, college tuition subsidies, and so on:” where is defense spending, which is about 43% of the federal budget? Is it even included in “benefits people receive from the government,” and if it is, how is it divided between the income quintiles?
It’s just smoke and mirrors. The paper (and Mac) haven’t backed up any claim they’ve made.
I dont understand how yall think that the benefit of a free and stable country only applies to rich people. the laws that enforce property and keep contracts are those that allow everyone to succeed and gives everyone a chance are achieving the American dream. I would argue that without these laws, the rich would be able to take advantage of to poor much easier, its a two way street that is impossible to measure.
as for defense spending, I will not argue that a large portion of the budget is defense, see chart:
http://www.heritage.org/research/features/BudgetChartBook/fed-rev-spend-2008-boc-S7-Despite-War-Costs-Defense.html
(~33% more now then under Clinton)
but spending a healthy amount on defense can do a lot to help the overall economy, and ensure the safety of Americans and American interest throughout the world.
Basho, what specifically about the Tax Foundation study do you find to be “utter rubbish”? Do you question the integrity of data used in the analysis? If so, can you point out any specific instances that are invalid? Sources and references are provided in footnotes and the report is written by a team of economists. Without further inspection I cannot find fault with the analysis.
Defense is the most important benefit provided by government, but it applies to everyone equally. All lives are equally important under the eyes of the law. That being the case it would make sense to exclude this benefit from an analysis of relative advantages derived from government expenditure.
Mac, everyone benefits from a free and stable America. I didn’t mean to imply otherwise and apologize if I’ve been confusing. This is one very important reason why everyone must pay taxes.
http://www.thefreedomfactory.us/everyone-has-to-pay-taxes-or-america-will-fail/
When we dissociate cost from benefit in an environment where people can potentially vote themselves benefits (Democracy), it is important to ensure that everyone pays for at least what they consume. Allowing people to get away without paying any taxes, but still vote for benefits is a recipe for disaster.
Im not necessarily upset at the fact that people who make more pay more. its reasonable. The reason Obama has me up in arms is that he wants to provide “refundable tax credits” big fancy word for a check to people who dont even pay taxes.
I would love to see fair tax passed, its a revolutionary idea that makes lost of sense. If anyone is unfamiliar, I suggest you research it thoroughly before you take a side. For lack of a better word, its a really cool concept.
Until fairtax gains traction, I’m simply supporting a flatter tax. John McCain wants to simplify the tax code to only two brackets.
what people need to understand, I think is simplified in the original post.
(sorry if this is a bit of an oversimplification)
with a flatter tax code such as McCain proposes ,
if person 1 makes 100,000 a year and pays 20% result= in 80000.
if someone who makes 50000 a year pays 20% result=40000.
they will still pay more, twice as much in fact.
with a steeper tax code, such as Obama proposes, it could look more like:
Person makes 100000 gets 40% taken resulting in 60000 in the end, and someone makes 50000 with 20% resuts in 40000
the 100000 maker now pays 4x as much as the 50000 maker even though he makes 2x as much
before I get yelled at for defending people who make 100000, there are alot of small business owners, and managers who work very hard and deserve their 100000. they got to those positions for reasons, outstanding skill or high level of education. I think these people should get their 100K. And even people who make millions, (this is harder to defend) they do so for a reason, Bill Gates (Microsoft) and Steve Jobs (Apple) built their companies from the ground up to what they are today, they used to be the ones coding for the original version of DOS or creating the apple II, they created something spectacular. and even though they make so much money they give a lot of it a way 1-65% on 100,000,000 is 65 million (even france as capped income tax at 50%) 2- some of the largest philanthropy efforts in the world. 3-investments back into theirs and other companies help drive the economy.
all the original post is trying to clarify is that the tax system works off of a percentage basis. and that even when the percent taxed is the same, the rich still will pay tons more.
P.S.
Rob, great posting on the everyone must pay taxes forum. I can see now that we are in more of an agreement then I thought.