Saturday, September 15, 2007

A Basic Lesson in Economics

Here is something I received in my email recently, in case you haven't seen it:

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 beers 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% saving s).

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 very 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!


Small Business USA said...

Dr. Kamerschen - Your argument holds water, your conclusion does not. People who make alot of money do not live in the US because the pay less taxes. They live in the US for any number of reasons but higher or lower taxes will not make them change their citizenship.

The only reason lowering taxes can represent higher tax revenue is because people evaluate the cost of paying taxes and the risk of getting caught. As they lose their financial advantage of not paying taxes they start following the law and eliminating the numerous tax scams allowed by our tax code.

If we want to fix the tax system we should eliminate all deductions, perks, incentives, et al and go to a straight flat tax without changing the percentages.

We could then look at the possibilities of lowering tax rates once we see that tax revenues is actually tied to GDP. The wealthy need the working class to make money otherwise they lose their markets.

E.T. said...

I have to wonder what university would give a PhD to someone who lacks a true understanding of the reality of the US tax system.
If one looks out the window, rather than watching Fox news, it is easy to see that his example is exactly the opposite of what is happening in America.
Reality? The wealthy patron gets his beer for free, the poorest patrons may get a beer but only from the kindness of the patrons in the middle. The vast majority of taxes in the US are paid by people in the middle income brackets. Even Warren Buffet was quoted recently saying his secretary pays more taxes than he does. Yes, the wealthy provide jobs for the "lower" classes. But the price the "upper" classes pay for citizenship is drastically out of proportion to the value they receive. So, in his conclusion corrected, the other 9 still have beers when the wealthy #10 stops coming to the bar. Why? Because the men in the middle have always paid for all of the beers they drank. Making the wealthy pay their fair share of taxes will not make them stop earning riches or leave the country. They'll only complain slightly more about their perceived injustice than they do already.
A man who makes $100 million cries like a baby when he pays $100,000 in taxes... a man who makes $100,000 gets no respect when he pays $28,000 in taxes. Do the math before you pity the wealthy...