Friday, August 13, 2010

The dangers of over-taxation of the wealthy

A friend of mine shared the following tale with me for explaining how taxes work...  I just wanted to share.  I'm not sure where he got it from but I know I'd seen it before he shared it with me... Feel free to dissect, refute, and/or completely tear this apart if you like... I'm actually putting this "out there" because I'd like to generate some discussion:

Suppose that every day, ten men go out for dinner. 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 $7, the eighth $12, the ninth $18, and the tenth man  "the richest" would pay $59.

That's what they decided to do. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement ? until one day, the owner threw them a curve (in tax language a tax cut).
"Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20." So now dinner for the ten only cost $80.00.

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

The six men 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 end up being PAID to eat their meal. 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 paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59. Each of the six was better off than before. And the first four continued to eat 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 who pointed to the tenth. "But he got $7!"

"Yeah, that's right," exclaimed the fifth man, "I only saved a dollar, too . . . It's unfair that he got seven times more than me!".
"That's true!" shouted the seventh man, "why should he get $7 back when I got only $2? 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 he didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered, a little late what was very important. They were FIFTY-TWO DOLLARS short of paying the bill! Imagine that!

And that, boys and girls, journalists and college instructors, is how the 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 at the table anymore.
Your thoughts?


Voice of Doom and Gloom said...

OK... Wow. That is the sloppiest bit of analysis I've seen in a long time. FIrst, basing this argument from the spending side is ridiculous. IF the governemt did tax cuts this way (by reducing spending 20% and THEN figuring out how to apply the reduction "equitably) we would all be far hppier than how it really works. Let's take an overly simplistic example, but still more realistic than this one.

Pre-Bush tax cut amounts (income- tax bill-percentage of total)
The total take is $573,174. Let's pretend that's what government spends. (The percentages add up to 100.04 because I was too lazy to do the rounding 100% accurately.)

Now come the Bush tax cuts (once again, way simplified - I'm not taking into account that the tax breaks shifted [up] and the lowered taxes on capital gains and dividends [which also favor the higher brackets]):
Now the total take is $525,967. But since Congress NEVER decreases spending (in fact it went way up), the higher brackets ($96,700 and up) now fund less of the cost of government than they did before. And, these percentage do NOT add up to 100%, but only 91.74%. The remaining 8.26%? Now we have to borrow! Adding to the debt, adding to the interest the taxpayers owe to China. The lower 2 brackets still pay the same % of the government spending they did before. So, who wins here? It ONLY works if they cut spending FIRST, then taxes. It has never worked the other way around, and it probably never will.

Voice of Doom and Gloom said...

I tried to be provocative to encourage some give and take and no one bit.

Perplexio said...

Since no one else bit-- I will:

You raise excellent points about governmental spending. Tax cuts, regardless of how they're distributed, do no one any good if spending isn't also cut proportionately.

Growing up I was raised to believe the GOP were the good guys and the Democrats were the bad guys... It's not so black and white and in Congress I'd argue that the corruption and lack of accountability and lack of fiscal responsibility is systemic. It knows no party lines and that's what the GOP proved when they controlled Congress between 1994 and 2006.

The current Democrats controlling Congress have done nothing to disprove the systemic lack of accountability, they've done nothing that indicates any semblance of fiscal restraint, and the corruption is still as rampant as ever.

I just hope that the next Congress-- whatever it ends up looking like after this November's mid-term elections-- understands that the mandate of the American people was not/is not really pro-Republican or pro-Democrat but actually anti-incumbent. We're sick of business as usual and I believe the mid-term elections will be a House-cleaning of sorts (emphasis on "House", there aren't enough vulnerable senate seats in play to tip the balance of power in the Senate this year... maybe in 2012).

Hourman said...

I'll bite... look the point of this parable was to show just who pays the taxes in this country, not whether the taxes collected are sufficent to feed the leviathan that is the government.

I agree with assertion that the government spends too much money, but disagree with conventional wisdom that deficits are caused by a lack of taxes beign collected.

If tax cuts decreased the amout of revenues colelcted, then following that logic, no retail store should ever offer sales, but instead raise their prices when times get slow.

Hard spending caps, reduction of entitlement programs, elimination of government programs such as public broadcasting (the 8-track player of the 21st century), and a reduction of the government work force will all go a long way toward reducing spending to match tax receipts.