Bar Stool Economics

[TulsaMoon]

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100 and 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." so 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, ladies and gentlemen, journalists and college professors, is how our tax system works. The people who pay the-- highest taxes-- are entitled to get the most 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.

Wonder how many will blast this post.. And yes its an old old one, but still...

[nathanm]

I see someone misunderstands how our progressive tax system works. Sad that it's a professor of economics.

[we vs us]

Did my Uncle forward this thing to you, too? 

Damn.  He's got EVERYBODY on his crappy-email-forward list.

[guido911]

I see someone misunderstands how our progressive tax system works. Sad that it's a professor of economics.

Oh I think this prof knows EXACTLY how the "progressive tax system" works. You just don't like it dumbed down to the point where its unfairness is easily exposed. But hey, feel free to enjoy being one of the four men livin large off the tenth man.

[nathanm]

Oh I think this prof knows EXACTLY how the "progressive tax system" works. You just don't like it dumbed down to the point where its unfairness is easily exposed. But hey, feel free to enjoy being one of the four men livin large off the tenth man.

No, he does misunderstand. He makes the common mistake of thinking that a reduction in the rate for the lower tax brackets does not also reduce the rate for people earning more than the cutoff for that particular bracket. Maybe he actually gets it but thinks other people won't understand and glosses it over to make it work as a parable.

Either way, it's dumb as a box of rocks.

[guido911]

No, he does misunderstand. He makes the common mistake of thinking that a reduction in the rate for the lower tax brackets does not also reduce the rate for people earning more than the cutoff for that particular bracket. Maybe he actually gets it but thinks other people won't understand and glosses it over to make it work as a parable.

Either way, it's dumb as a box of rocks.

Why is it that an American living in this country should pay more in taxes than any other American living here? I really want to know why it costs more for me to live here than you. Tell me.

[Red Arrow]

No, he does misunderstand. He makes the common mistake of thinking that a reduction in the rate for the lower tax brackets does not also reduce the rate for people earning more than the cutoff for that particular bracket. Maybe he actually gets it but thinks other people won't understand and glosses it over to make it work as a parable.

Either way, it's dumb as a box of rocks.

I don't feel like figuring out your way. (Too lazy and may use different assumptions.) Please do the math for the example above doing it your way.

[nathanm]

Why is it that an American living in this country should pay more in taxes than any other American living here? I really want to know why it costs more for me to live here than you. Tell me.

Because the tax is a percentage of your income, silly.

As for how it is that a tax cut for the lower and middle-income brackets translates to a cut for people making over that? You don't pay a flat 35% on all of your income just because some of your income is taxed at the top rate. All of your income below the top rate is taxed at the applicable rate for that bracket.

Say you file married filing jointly and your family's income is $200,000, after the exemption and any applicable deductions. Presently, you pay about $44,000 in tax, or about 22%, and you would not be affected by the contemplated reversion to the former rates. If your family's taxable income were $250,000, you presently pay about $60,000 a year in tax (24%), and would pay an extra 3% on the income over $209,250, so about $1,222 (six tenths of one percent) more each year if the Bush rates were to expire. If your family's taxable income were $400,000, you presently pay about $110,000 a year in tax (27.5%) and would pay an extra 3% on income between $209,250 and $373,650 and an extra 4.6% on income over that, for a total of $6144, or 1.5% of the total income.

A couple earning a cool million a year (after deductions) presently pays $320,000ish in tax (about 33%). They would pay an extra 4932 + 28812, or an extra 3.3% of total income.

Conversely, if the bottom 3 brackets were each dropped 5%, every couple earning over $137,300 would pay $6865 less in tax each year, because the first $137,300 would be taxed at 5% less. Thus, a tax cut for lower income earners is a tax cut for everyone.

The failed parable makes it seem as if a cut in the price of beer for the lower brackets without a cut in price for the higher brackets would not in fact reduce the price of beer for everyone who already pays for beer. He also vastly inflates the difference between the lowest and highest beer price brackets. There is no 59% tax bracket, nor a 1% tax bracket. I guess I could rewrite the whole thing, but that seems like more effort than it's really worth.

[guido911]

Because the tax is a percentage of your income, silly.

That is a fantastic non-answer. I pay more because I am supposed to pay more.

[custosnox]

That is a fantastic non-answer. I pay more because I am supposed to pay more.

So you don't think that taxes should be based on a percentage of yoru income?

[we vs us]

That is a fantastic non-answer. I pay more because I am supposed to pay more.

You pay more because we think your money is better than the other people's money. We really just can't get enough of it. It's only natural that we use the power of the state to take as much of it as we can.

[Red Arrow]

You pay more because we think your money is better than the other people's money. We really just can't get enough of it. It's only natural that we use the power of the state to take as much of it as we can.

If his money is better (worth more) than other people's money, it shouldn't take as much of it to pay his fair share. If his money was worth less (or maybe worthless) then taking as as much of it as possible would be required for him to pay his fair share.  Make up your mind.

The issue really is that because someone has more, the people with less (and the people running for office that want people with less to vote for them) think that the people with more should pay the way for everyone.

[Red Arrow]

The failed parable makes it seem as if a cut in the price of beer for the lower brackets without a cut in price for the higher brackets would not in fact reduce the price of beer for everyone who already pays for beer. He also vastly inflates the difference between the lowest and highest beer price brackets. There is no 59% tax bracket, nor a 1% tax bracket. I guess I could rewrite the whole thing, but that seems like more effort than it's really worth.

The so-called failed parable makes the assumption that each person paying should pay approximately the same percentage before and after the discount but actually gives a slight advantage to all but the top payer.

The new bill is 80% of the original bill
80% of $1 is $.80, drop the fraction and the bottom paying guy pays nothing.
80% of $3 is $2.40, drop the fraction and his bill is $2, 2.5% of $80.
80% of $7 is $5.60, drop the fraction and his bill is $5, 6.25% of $80
80% of $12 is $9.60, drop the fraction and his bill is $9, 11.25% of $80
80% of $18 is $14.40, drop the fraction and his bill is $14, 17.5% of $80
2+5+9+14=$30, leaving $50, not $49, for the last man to pay.  Roundoff obviously enters the math.
$50 is 62.5% of $80. (The rich guy previously paid 59%.)

It is unlikely that the "failed parable" was intended to exactly match the tax brackets. It is more likely to have been an exercise to show a principle and get folks to think of unintended consequences of pursuing the popular path.

http://www.snopes.com/business/taxes/howtaxes.asp


If your goal is to have the rich pay a higher percentage of the total bill, we can proceed from there.

Lowering the marginal rates at the lower income level without lowering the marginal rates at the higher income levels will reduce everyone's total number of dollars on the tax bill.  It will, however, shift the burden in terms of percentage (not just $) to the higher brackets.  Let's take this to a limit (remember Calc I?).  Let's eliminate all income taxes below $200,000.  ($250,000 sounds nice but not everyone is married with a home mortgage.) Even the wealthiest will see a reduction in their total tax dollars since, as Nathan points out, not all dollars are taxed at the highest level.  Now all the taxes are the responsibility of those making more than $200,000.  While that would help me significantly,  I don't think it would be fair.  Short of providing too much information, my income is considerably less than $200,000.

The above does not, and is not intended to, address Social Security, property, and sales tax.

Social Security presently has benefits based on contributions.  Everyone should get more out than they put in just based on the time value of money. (Interest paid on deposits.)  I am well aware that payments are a generation behind but the concept of getting more actual $ out than you put in does not bother me.   The fact that rich people don't pay the same percentage of their gross adjusted salary doesn't bother me either since their benefits will depend only on the income on which they paid social security taxes, not their gross income.

Everyone pays property tax.  If you rent, part of your rent pays property tax.  Renting is frequently less expensive than owning because the properties are typically older and less expensive or of lesser quality. Some of the higher rents for new development or refurbs downtown represent the cost of those projects. Rich people typically pay a lot more property tax because they typically live well.  Better than me anyway.

Sales taxes can be remedied by not putting sales tax on necessities. I don't know the present status but when I lived in PA, there was no sales tax on food, clothing, and prescription drugs.  Soda/pop was taxed, cauliflower was not. Swim suits were taxed, underwear, slacks, shirts, blouses, dresses, etc were not taxed. It would be even less difficult now with all the computers involved in retail sales.  Sales tax does not need to be regressive on necessities.  You want a color, large screen TV?  That is not a necessity and I don't care what percentage of your income it costs, pay the tax.

The comments I saw on the Snopes site typically attacked the fairness rather than the math.

Nathan, I am truly surprised that you cannot see the principle of the parable even though I thoroughly expected you to disagree with the concept. Requiring the parable to exactly follow the present income tax  codes and marginal rates is beneath you.

[Red Arrow]

So you don't think that taxes should be based on a percentage of yoru income?

I can't speak for Guido, but there are some that believe that taxes should not be based on a percentage of their income. Some believe the income tax is wrong, period.  The other alternatives include property tax. Why should I pay money to the government to keep something I already own?  The other common alternative is a consumption or value added tax. This is usually considered "regressive" but could be reasonable if necessities were exempt.  Defining "necessities" could be as difficult as defining "income".  "Use tax" is one of my least favorites.  It usually is equal to the sales tax for something bought out of state.  Buy a shirt on the internet and you owe "use tax" in order to own it in the state of your residence.  Some states are even worse than Oklahoma.  Take your airplane to Maine and land at an airport there and you owe use tax equal to the Maine sales tax on the purchase price (or maybe fair market value) of your airplane.(Details may not be exactly correct but the principle is.)  This may have changed since I last looked but you can be sure I am NOT going to Maine in my airplane.

Just remember..... It is NOT your money.... and  you will be a happy camper.  Broke but happy.

Given that we have an income tax:
I believe that if I make twice as much as someone else, my taxes should be twice as much as theirs, not more than twice as much.  The exception to that would be a deduction for a basic cost of living for everyone regardless of their income.  Make $50,000 and you get a (pick a number) $20,000 deduction. Make $50,000,000 and you get the same $20,000 deduction.  This is obviously a lot larger percentage of your income if you make $50,000 than if you make $50,000,000.  Advantage: poor guy.  Taxable income in this example would be anything above $20,000.  I am not in favor of giving everyone with an income (in this example) less than $20,000 an amount required to bring their income up to $20,000. "Everyone" would include dependents on someone else's return.

I am well aware of the "let them eat cake" syndrome.  I am willing to help someone unable to help themselves. I am unwilling to help those unwilling to help themselves.

[nathanm]

The reason for progressive taxation is that the 200,000th dollar of income has more marginal utility than the 20,000th dollar. Roosevelt once said that higher income earners should feel privileged to be in a position to pay more.

Beyond that, there are useful economic reasons to have higher income earners paying more of the total bill. The velocity of the 20,000th dollar is far higher than the 200,000th dollar. It's much more likely to be spent and thus generate economic activity. Moreover, it's more economically efficient to have less drastic (but not no) variation between the spending power of the highest income earners and lower income earners. It gives the higher income earners, who often make much of their income selling stuff to other people, a bigger market in which to sell.

Additionally, people who have a higher income generally use more of the resources provided by the state.

A lot of folks like to claim the only justification for progressive taxation is jealousy, but that's clearly not the case. The parable attempts to gloss over that fact.