How Our Tax System Works

Or… Economics 101

This was sent to me this morning by a colleague. It’s an interesting “Joe Six Pack” explanation of the tax system, which even “Joe the Plumber” would understand.

Suppose that every day, ten men go out for drinks 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 restaurant 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
drinks 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 drink. So, the restaurant 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 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

9 thoughts on “How Our Tax System Works”

  1. I’m not scared of math or of calling a spade a spade! Our tax system sucks. Seems like I’m always the one paying for other people’s drinks, but am still in debt. Just not fair.

  2. I think it’s a great illustration. I think i’ve mentioned to you the book Atlas Shrugged by Ayn Rand…. it’s basically about the modern world where all the entrepreneurs have left society to create their own little utopia, and the havoc this causes in the rest of the world where everyone tries to gobble up whatever is left over.
    Piss off all the rich people and they will say “screw it” and leave everyone to whatever they want to do.
    Which is, in the end, communism and then anarchy.

  3. I'm not sure how this economics professor arrives at his figures.

    First off, I'm assuming he's saying 40% of the population pay <1% of the taxes, all the way up to 10% who pay 59% of the taxes (with gradations in between)? That's because Men #1-4 paid <$1, Man #7 paid 7% * $100 = $7, and Man #10 paid 59% * $100 = $59 on the $100 tab.

    So, why bother calculating anything on that $20 discount on the booze at all? Just take the $80 and apply the same percentages. Men #1-5 pay <1, Man #7 paid 7% * $80 = $5.60, and Man #10 would pay 59% * $80 = $47.20.

    Here are the problems: First, Man #10's cost was calculated incorrectly as $49 instead of $47. But that could have been because he picked up all the loose change left over from the rest of the gang. Man #7 had a nice round number of $7 from the $100 tab, but, according to the prof, only had to pay $5 from the $80 tab. Where'd the extra 60 cents go? That's a little less than 1% of the whole tab, nothing to sneeze at.

    Not to mention, Men #1-5 wouldn't get off scott free. They'd still have to pay something between 01 and 99 cents on their bills.

    So, are all these guys idiots – complaining they got less savings from less investment?

    I'm not sure, beyond even the bad math, that the example of the squabbling illustrates more than just the same old conservative vs liberal, rich vs richer talking points.

  4. Obviously the numbers are very (VERY) rough estimates used to illustrate a point. I don’t think that nitpicking the math does anything to change the overall gist of the professor’s message, that being: look at the bigger picture before you draw conclusions about your individual contribution. Everything is relative, and overreacting to your own situation versus someone else will likely lead to unwanted consequences.

    Fact is, all tax systems suck, i don’t believe there is a most “fair” way to do it and never will everyone agree on a particular system. Personally, i strongly oppose overtaxing the rich for the supposed benefit of the rest, it only works for the short term and will cause much bigger problems down the road.

  5. Well, I’m still a bit leery at the expertise of an economics professor who can’t get his basic math right.

    But what bothers me is his reliance on the fact that the 10 men are stymied over trying to divide the $20 savings, rather than accepting the obvious solution of taking the same percentage from the two different amounts. Are there people out there that don’t understand the same percentage of corresponding lesser totals will get smaller? And that their proportions will reduce in the same way as their friends?

    The squabbling at the end I can see in a way, because people squabble over silly things like money all the time. But the conclusion seems forced, as if it was foregone to support his contention that the rich pay more taxes and the story was crafted to fit the solution.

    It’s also not addressed that, in today’s world of a defined living wage, that the richer among us can afford to lose more and the poorer can afford to lose much less. So that the richest man can afford to pay $59 for the coffee and still (metaphorically) live comfortably. The poor men can barely afford to buy coffee at all.

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