Friday, October 24, 2008

Government, Beer, and Our Tax System

Someone putting himself forward to be President of the United States should know at least the basics of economics. But the Democrats in general show little evidence that they know anything of the subject. They seem more concerned about what they call "fairness" than about general prosperity.

For example, after the Democratic Congress passes Barack Obama's tax increases on "the wealthy" and sends checks to everyone else--thus establishing "fairness"--48% of the voting population will be paying no federal income tax. Another 11% will be paying very low taxes.

Surely, you can see the problem. What do you think happens in a democracy when the majority of the people pays no taxes, and yet has the power through Congress to raise the taxes of those who do pay, and gives itself ever increasing benefits with other people's money?

After passing that tipping point is there any going back? Why would people who pay no taxes vote for going back to paying taxes? They will view freedom from taxation as an entitlement. Tax cuts will become a thing of the past. Any proposed tax cut would be a "giveaway" to the rich because they would be the only people left paying any taxes.

But as government spending for those who pay nothing goes up and up, and the tax rates on an ever shrinking minority get increasingly burdensome, those who pay the bills will have ever incentive to work, or at least to work in America. Again, you see the problem. Eventually, in the throws of national bankruptcy and poverty, seeing that we have killed the goose that lays the golden egg, or driven her into exile, we will have to mend our ways and resume the broad civic responsibility of paying taxes. In the meantime, we will see likely two generations of unnecessary suffering.

Adam Lerrick, economics professor at Carnegie Mellon University, explains this crisis in "Obama and the Tax Tipping Point" (Wall Street Journal, Oct. 22, 2008). Michael Boskin mentions the same point today in "Our Next President and the Perfect Economic Storm" (WSJ): "[Obama's] refundable tax credits will raise the share of those making no contribution to the funding of general government to 48% from 38%, hastening, perhaps cementing, the unhealthy budgetary dynamic of a majority of voters receiving more in public payments than they pay in taxes."

Here is a different approach to the same lesson stated more playfully and perhaps for that reason more effectively:

How Taxes Work ― or, 'How to Pay for Beer'

"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. Then he pointed at 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, 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.

This illustration has been attributed to David R. Kamerschen, a professor of economics at the University of Georgia, but on his webpage he denies authorship. has investigated all leads on the authorship of this brilliance and come up dry.

Always check your sources! Always footnote!

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