U.S. Income Taxation Explained with Beer (Analogy)
I don’t usually paste long quotes into blog posts but this one is difficult to break up without disrupting the flow. In a nutshell, it offers a very simple and somewhat humorous analogy of how the U.S. income tax system works by comparing it to the responses of ten beer-drinking men.
Since our Presidential election is less than 3 weeks away I though it might be appropriate to consider income tax policy from a non-partisan, “middle class” perspective. You might even learn something about tax cuts and taxing the rich and all those other political buzzwords.
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 real 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.
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.
I’m not sure who to attribute the above analogy to since it has been “floating” around the Internet for a long time. I was reminded of it again today through a friend who sent me a link this blog post [no longer published — was http://obama2.com]. I did some searching and a few blog posts gave credit to David R. Kamerschen, Ph.D. [link no longer valid — was http://davidk.myweb.uga.edu/], Professor of Economics at the University of Georgia (however, his bio already notes that he is not the author of another piece floating about the Internet so I am doubtful he wrote this one either). In any case, I think the analogy is interesting and, in spite of its limitations and the obvious disconnect with reality, it’s worth thinking over.
Edited on 2015-Oct-15 to remove broken links.
Interesting analogy. It kinda makes sense though because even though the richest person got the biggest discount he’s also paying substantially more than everybody else. But the final point about what happens if he leaves the country is very poignant. We’re incentivised to work outside the country by getting huge tax breaks for staying out for a year or more. With the ability to work online this might become very appealing to some individuals.
This is completely incorrect…and out of context.
First off, the examples listed infer that the rich are paying 60 percent of their “individual” income taxes. This is not true; they are paying 35%, which is the highest of all of the 6 tax brackets that currently exist. Now even that 35% is rarely paid by the wealthiest persons, the rich can take advantage of tax loopholes, including one that allows them to pay the capital gains tax rate of 15 percent instead of the ordinary top income tax rate of 35 percent.
Recently Warren Buffett (the third-richest person in the world) cited himself as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent. Buffett said that was despite the fact that he was not even trying to avoid paying higher taxes. “I don’t have a tax shelter,” he said.
Now lets talk about context, the 60 percent paid by the wealthiest man outlined in the horrific example, is to depict the total amount of income tax revenue received. Therefore, stating that the Top 5 percentile of wealthy Americans in this country make up 60 percent of the entire income tax revenue received. The top 5 percent own 60 percent of all wealth. So, now that you can see that the Top 5% owns 60 percent of our nation’s wealth, you should also understand why they also make up 60 percent of the yearly income tax revenue
Also, the top 20 percent owns over 80 percent of all wealth. In 1998, it owned 83 percent of all wealth.
Finally, if you tax someone making $40,000 a year 25% you take $10,000 dollars from them leaving them with a windfall of 30,000 dollars.
But if you tax Warren Buffet, making $46,000,000 a year, 35% you take $16,100,000 dollars, leaving him in poverty at 29,900,000 dollars. And as I said earlier, with the tax breaks and loopholes they see, they end up paying only 17% compared to the 25% the 40k a year is taxed. And good luck going to a non-third world country, offering a different system or at a lesser rate; England is taxing their rich higher at 40%, China at 45%, Canada is the lowest at 29%, but they don’t even tax those making less than $9,000 a year, period. Don’t accept these “jokes” at face value, do your research!
“First off, the examples listed infer that the rich are paying 60 percent of their “individual” income taxes. This is not true; they are paying 35%, which is the highest of all of the 6 tax brackets that currently exist.”
Obviously, the rich man is not supposed to represent a single person, but the top 10% of earners. And the entire top 10% of our country pays about 59% of the taxes, hence the analogy makes sense.
The point is not to say that the wealthy should not pay a larger portion of their income to taxes. The joke is analyzing people who criticize tax breaks, arguing that the rich get them too often. Well, the people that pay 60% of the taxes should get 60% of the break.
So, to Steven (Nov 7) who thinks the MAX Tax is only 35% and the Rich pay way to little. My recommendation is to take a Math or a Tax course.
We Start with 35% Federal, Add 10% State CA, another 8-9% Sales tax, Try Gas Tax, Property tax, then there is Medicare & Social Security Tax – Yes its a Tax cause the “rich” will never see anything out of them. Then we can discuss the luxery taxes. Then there are all those non deductable expenses. Last year my take home was < 30% of my net income.
Frankly, I am tired of paying for your beer.