Every once in a while, I find myself pondering the complicated subject of taxation and the economy. Social Security, the deficit, Iraq, oil … somehow, it’s all supposed to make sense. Instead, I get so overwhelmed by all the numbers that I usually just throw my hands up in frustration and forget about it.
Then I came across this little story by David R. Kamerschen, Ph.D., Professor of Economics at the University of Georgia – and it became crystal clear. It’s like one of those fables you may have heard when you were a child. The ones that make even the most complex ideas seem very simple.
This story may not leave you with the warm, fuzzy feeling the three little pigs did – but go ahead and read it. See what you think …
Suppose that, every day, 10 men go out for dinner and the total bill comes to $100. Suppose, too, that they decide to pay the bill the way we pay our taxes. This is what happens:
The first four men (the poorest) pay nothing.
The fifth pays $1.
The sixth pays $3.
The seventh pays $7.
The eighth pays $12.
The ninth pays $18.
The tenth man (the richest) pays $59.
The 10 men are happy with the arrangement. But then, one day, the owner of the restaurant throws them a curve. “Since you are all such good customers,” he says, “I’m going to reduce the cost of your daily meal by $20.” Dinner for the 10 now costs just $80.
The group still wants to pay their bill the way we pay our taxes, so the first four men are unaffected. They still eat for free. But what about the other six men – the paying customers? How do they divide the $20 windfall so that everyone gets his “fair share”?
They realize that $20 divided by six is $3.33. But if they subtract that amount from everybody’s share, the fifth and sixth men would end up being paid to eat their meals.
So the restaurant owner suggests that it would be fair to reduce each man’s bill by roughly the same amount – and he proceeds to work out how much each one should pay.
The fifth man, like the first four, now pays nothing (a 100% savings).
The sixth now pays $2 instead of $3 (a 33% savings).
The seventh now pays $5 instead of $7 (a 28% savings).
The eighth now pays $9 instead of $12 (a 25% savings).
The ninth now pays $14 instead of $18 (a 22% savings).
The tenth now pays $49 instead of $59 (a 16% savings).
All six of these men are now better off than they were before. And the other four continue 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,” declares the sixth man. He points to the tenth man, “But he got $10!”
“Yeah, that’s right,” exclaims the fifth man. “I only saved a dollar too. It’s unfair that he got 10 times more than me. ”
“That’s true!” shouts the seventh man. “Why should he get $10 back when I get only $2? The wealthy get all the breaks!”
“Wait a minute!” the first four men yell in unison. “We didn’t get anything at all. This system exploits the poor!”
The nine men surround the tenth and beat him up.
The next night, the tenth man doesn’t show up for dinner, so the nine sit down and eat without him. But when it comes time to pay the bill, they make a disturbing discovery. They don’t have enough money between all of them to cover 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 stop showing up. In fact, they might start eating overseas, where the atmosphere is somewhat friendlier.
“You don’t pay taxes – they take taxes.” – Chris Rock
(Ed. Note: Alex Molina is president of A&M Financial Service Group Inc., a client-oriented brokerage specializing in strategies for income, real estate, taxes, and retirement. He can be reached by e-mail at email@example.com.)