Friday, March 03, 2006

Tax Cuts - A Simple Lesson in Economics

Tax Cuts - A Simple Lesson in Economics

This is how the cookie crumbles. Read it carefully. Let's put tax cuts in terms everyone can understand.

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 5th pays $1
Sixth would pay $3
The seventh $7
The eighth $12
The ninth $18
The tenth man (the richest) would pay $59.

So, 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.

"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.

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 each 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, like the first four, now paid nothing (100% savings)
The sixth now paid $2 instead of $3 (33% savings)
The seventh now paid $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 $59 (16% savings)

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. He pointed to the tenth. "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 me!"

"That's true!" shouted the seventh man. "Why should he get $10 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 the tenth man 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 something 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 at the table anymore. There are lots of good restaurants in Europe and the Caribbean.

David R. Kamerschen, PhD
Distinguished Professor of Economics
536 Brooks Hall
University of Georgia

Seems like an academics way of making he still gets a big tax cut to me. The tone of the text is quite patronising too.

I don't see why we just don't have a flat tax rate, the GSTs flat rate was touted as a way that if you earnt more, you paid more, why can't income tax work like that. The tax bracket system we currently have does seem to favour those who earn the least. I reckon a flat rate of 25% (Singapore uses a flat rate of 15%) would work quite well and simplify the tax system at the same time.


Anonymous said...

You can’t make everyone pay the same income tax rate simply because it would devastate the people who don’t earn the big dollars.

A low income earner earns $25k a year. A high income earner earns $90K. The low income earner will pay 25% of his $25,000 which is $6250 income tax. This leaves the low income earner with annual wage of $18,750 or $360.57 per week. On the other hand a high income earner will pay $22,500 income tax which leaves him with annual wage of $67,500 or $1298.07 per week.

With today’s economy, only one person will live a comfortable life whilst the other will be fighting to stay alive.

So in other words what I'm trying to say is that a flat tax rate will hurt the low income earner much, much more then it will the high income earner. A flat income tax rate would also hurt the economy too.

Nick said...

I agree on the flat rate tax. The GST was supposed to even out the playing field with high vs low income earners. The high income earner has more income therefore will spend more and get taxed on purchases. The low income earner won't have the same disposable income and therefore won't waste their money. The basics to live on are supposed to be GST free (or most are anyway) allowing the low income earner a tax break.