Bar Stool Economics & How Taxes Work
Here’s a little story my friend Matt sent me and it’s about economics, taxes, and drinking; only one of which I actually enjoy. I didn’t double check the math but it appears sound and the message is pretty interesting (especially given the talk of the 2008 tax stimulus package!). I invite you to share your thoughts in the comments.
(The origins of this story, as well as some of the story details, are unclear but it’s still an entertaining and thought provoking read)
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. What happens to 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. 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, 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 anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
(Photo by ricktoomer)
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There are 17 comments, add your thoughts now!
I want tax cuts for the rich so that they will be able to buy more, invest more and hire more employees.
We are slowly killing the golden goose in our country.
That story is illustrative, but only to a degree. Like the Laffer curve, the story makes the sensible point that if you overtax the rich, tax revenue will go down and everyone suffers. But also like the Laffer curve, the story doesn’t indicate how much is too much. I pity the legislators who have to guess at the right tax rates. They can’t make everyone (or sometimes anyone) happy.
The tax story makes the erroneous implication that those guys actually get something from government.
Question: why should someone earning menial wages in the private sector (e.g. a minimum wage janitor) pay high taxes to support a government worker doing the same thing (e.g. $50K government janitor) for an inflated wage?
Don’t forget all those tax breaks which make it possible for millions of families making $50K-$100K to pay a lower effective tax rate than someone toiling at a menial job for $20K with no tax breaks.
Got employer-provided health insurance and other fringe benefits? Got a homestead exemption? Got deductions for property taxes (which are lower to begin with thanks to your homestead exemption) and mortgage interest? Got a cool $500K capital gain tax free when you sold your home?
Is this a great country or what?
Please don’t forget tax breaks are a reduction in expenses paid to the government usually as an incentive take a risk with hard earned money saved that your average joe would have blown on beer,cigarettes and lotto tickets. To speak negatively about one for qualifying for a tax break is just wrong.
Or how about we stop government from spending so much money. If our spending was at the same level as it was 10 years ago no one would need to pay income taxes.
The story leads out a few details that would truely equate it to reall life. First, the amount for sales tax and the tip would be paid by everyone, even the men who “didn’t pay anything.” (This would be equal to state sales tax that basically everyone pays, and the tip would be equal to Social Securtiy and Medicare Taxes paid begining with the first dollar earned. The only difference would be that the rich men would only pay a tip equal to a certain threshold… just as they do with Social Security Taxes, and this amount would be lowered by a deduction they would take for being self-employed. (Assuming they are self-employed.) Also if we really want to be realistic the first portion of the beers were paid for by everyone because the wealthier gus didn’t start paying until they reached the first tax bracket, but everyone paid with their social security and medicare taxes. Secondly, it forgets that the amount they paid for the beers would be reimbursed to them as a business expense from their own LLC, which then writes the amount of this reimbursement as a tax deduction. The same scenerio takes place for the cost of their auto expenses getting there, and probably several other things as well. Oh, and I forgot to mention that their LLC that paid for the beers was actually paying for it with a combination of the rent the men with them were paying for their one bedroom, low income housing apartment owned by the LLC, and the tax breaks and other incentives the government gave the wealthier men for being so kind as to rent the low income housing apartments. So in the end the drinks are actually nearly entirely paid for by the poorest men.
Oh, that is *fantastic*!
Um, not quite does it work that way. This woman in CA makes $90k/year but she pay 5.7% in federal taxes. She’s a CPA and explains it beautifully. http://monkeymama.savingadvice.com/2008/02/05/mortgages-taxes-gas_35183/
So how does the richer on the people pay more? I think this is true for quite a lot of people.
This story only works if you believe that someone who is already getting an incredible price break on their beer would be sober enough to complain about the supposed break the wealthiest was getting. I say supposed because I believe mr. averageamerican’s analysis is by far the most accurate. Besides that, we know all those rich people have bodyguards to prevent anyone from getting too upset when someone notices how much they are getting away with.
I don’t spend money on beer, cigarettes, or lotto tickets, so I figure I’m sober ande have a right to complain.
Wow, great post. I completely agree with this with one exception. We don’t want to abuse the wealthy with ridiculous taxation, but they need to see how much benefit they got from being here in the first place. It is very unlikely for guy #10 to have been able to become as wealthy as he has if he was born in any other country other than the US (OK maybe W. Europe but their taxes are even higher than ours).
On a similar note, how much would any of you be willing to pay at birth to have been born in the good ole USofA? I know I would certainly pay a lot and so would many other people. Now, flip that around a little, if you manage to become wealthy during your lifetime how much would you be willing to pay to have been born in the USA (meaning someone would go back in time and make you be born in a random other country if you don’t pay up). I’d pay almost everything to ensure I (and my children, and so on) to ensure the freedom and opportunities that being here gave me.
Now that everyone is thinking on the right page, we can talk about income and estate taxes.
Besides, going to an unfamiliar bar to drink by yourself is pretty lame.
I think it is a wonderful story, but leave storytime for a moment and look at the UK and Ireland. Compare when the UK had an effective 90% tax…Those making money fled!
How did Ireland right itself? It lowered taxes to bring jobs in.
Beating the rich will get you elected and empty the coffers!
Hmm, interesting allegory. Let’s extend it a bit further:
The rich man, having been badly beaten, decides “I don’t need anybody else. My riches are sufficient, and all these poor people are living off my sweat and hard work! I’ll form my own society, where these types are not invited!”
The rich man forms his own society where he can enjoy the fruits of his labor. However, he quickly discovers that no one takes this strange foreign currency, “US Dollars”. Additionally, his new society doesn’t seem to value his ability to sell real estate over the internet, or collect rent from his income-producing properties. “Why can’t you make us a shoe, or build a house?” they ask him.
Now desperately poor and alone, the formerly rich man wishes he could pay his taxes and thus retain his feeling of superiority over his former friends.
Some of these comments are really amazing. I forget sometimes just how much “rich” people are hated.
I realize as a country people will never be in agreement as to what confiscatory taxes should be spent on but in our 200+ year history when did it become okay to take more from your neighbor because you don’t have as much as he? And on top of that berate him for having some left over?
Some of the commenters here have provided the same tired comments on many other sites. They’re trolls. But for the others who honestly feel that it’s okay, by threat of force, to take money from one American and give it to another I have to ask…how is that fair?
Ron
Here are some points to think about:
Due to the mass circulation of this email, the Professor, Dr. Kamerschen, has denied having anything to do with it. I can only assume that is due to its simplicity. If you google his name, that is the first thing that pops up.
Overall, it sounds good. I would say the alluring part of, “Hey that makes sense”, is that you can’t argue with the math (fractions) incorporated in the analogy. What you can argue with - is the analogy though and how the numbers are applied.
I have my reservations on this analogy for one major reason, the fact that it simplifies the entire social economic makeup of the country by trying to suggest it with percentages of tenths and placing the super rich with the poorest of poor at the same bar drinking the same beer.
For example, the email labels the country makeup into basically 7 classes – which is close to what most people would use. Most people look at it this way: you can break the US into 6 classes – Upper Class (Rich) 1%, Upper Middle Class 15%, Lower Middle Class 30%, Lower Working Class 30%, Lower Working Poor 30% and the Underclass (Poor) 12%. Now the email’s analogy tries to throw 10% of the population as the rich people paying all these taxes and unfairly treated by tax returns and that 40% are ungrateful no good rift raft, who doesn’t work or pay their share, but gets to enjoy the beer. Is that accurate? If you divided the country up per 10 people in the bar, it would be 0.1 persons being the rich guy and 1.2 persons being the destitute poor – with the working and paying stiffs in middle being 8.8 people.
The email leaves out what percentage (%) of the rich guy’s total yearly income he is paying towards taxes though, as compared to the rest.
I have a question; does the entire 12% of the population in the destitute class get everything free? And with that said, are they drinking the same beer as the rest of us, or even the upper 1%. I think the upper 1% is drinking something a little bit different than those 4 guys or actually 1.2 guys on the bottom.
If you look at unemployment rates, it would be something like 0.5 people not able to contribute to paying for the beer. If I keep defending the super poor point, I might start sounding like Mother Teresa…
Let’s look at the middle. While researching, I was a little annoyed to find myself not as well off as I might think. Most people I know think that the tax cuts for the rich include them. The upper middle class is described as white collar with graduate degrees, middle and upper management, with $100,000 income. The lower middle class is the bachelor degrees white collars and specialty trade college or high school educated making up to $75k. The Lower classes of the working class and working poor, key word “working”, are those in the blue collar world, repetitive manufacturing positions or service industry making $20k to $40k (hell that even sounds like the teachers of our children). The underclass, or the destitute, of coarse make something around 0 to I think $12k (that makes up some 37 million people – lazy bastards – all of them)….I guess I am lower middle class after all.
The upper class, comprising of 3 million folks out of 304 Million, make $350,000 per year or more. Most of them are executives of companies, inheritance winners, or specialty rich (sports, entertainment etc.) I would like to see what percentage of those people started out in the lower or upper middle class and worked hard and smart to get to the upper class. I fear that the number isn’t too high and the odds might be stacked against me…but I will dream and I will try. But if I do make it there, I doubt I will be complaining about paying 30 something percent of my earnings to the government. I think right now it is less than that.
I think that most societies of the past worked well with having a happy middle and not too big of a poor class. Once you get too much descent with the masses (301 million people compared to the 3 million that the below email is scared of), you can have chaos and rebellion.
Would all 3 million of the super rich leave us and go to other foreign countries to spend their money? Is this really a good analogy to use? Some may say that most of the 3 million wouldn’t be where they are without the spending and working power of the middle class (you and me). The beer/bar analogy is making it sound otherwise…”If it wasn’t for the rich, I guess there wouldn’t be an America.” I thought if it wasn’t for the great middle class there wouldn’t be an America…that is what built this country, right.
Let’s not confuse a rich person with corporations, even though they are considered the same under the law in regards to rights. Corporations move their money overseas, not people.
So, is the tax analogy correct or is it actually paying the correct picture? Were the numbers used describing reality? Do you and I pay the same percentage of our yearly wage the same as those fortunate enough to have so much wealth?
If you were so filthy rich, would you mind paying for a poor man’s beer? Are other country’s better at treating their rich, or do they just have too many poor people and not enough middle class to support the prospect of becoming rich? I would think that more baseball stars would live over-seas. Why hasn’t Bill Gates moved to…”insert country’s name who tax their rich less than the US”.
Darn those politicians trying to give those lower middle class people less burden. They must know there are 182 million people in the low mid to working classes who vote.
Finally, a word from the great Lady of Liberty herself, “Give me your tired, your poor, Your huddled masses yearning to breathe free, The wretched refuse of your teeming shore. Send these, the homeless, tempest-tost to me, I lift my lamp beside the golden door” -from “The New Colossus” by Emma Lazarus (on pedestal of statue).
My ten cents or sixteen.
The most important detail left out of the story is that the 10 man ( the wealthiest one) owns the bar.
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