The Tax System — Explained With Beer

An Enron tax lawyer told me this:

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. 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.

For those who understand, no explanation is needed.

For those who do not understand, no explanation is possible.

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Comments

  1. Great analogy. No doubt I’d have paid more attention in Econ 101 if my professors had used beer analogies instead of widgets.

  2. Pat Moffitt says:

    Great!—- How many beers each patron drank perhaps could ad to this lesson –given four drink for free.

  3. ilovecress says:

    That story has been doing the rounds on email for a couple of weeks now – it’s called Barstool Economics. It’s laughably oversimplified, and ignores the issue that the Bar is in massive debt so shouldn’t really be giving the $20 away in the first place.

    • OK, the bar “gave away” $20. Until the guy paying $49 doesn’t show up… and now the bar is out $49 bucks that night, instead of $20. And they’ll be out $80 every night thereafter. And may have to raise prices to get that money back, thus losing other customers… And thus closing. That’s no way to pay off a debt either.

      Laughable? Not to the bar owner. And “the highest does not stand without the lowest.” Complicating the economics doesn’t change the basic rules. One basic rule is – those twenty bucks were never the bar’s money to begin with. Until the tap runs, the bar has NO CLAIM on that money.

  4. NoFreeBeer4Me says:

    Except that we don’t actually pay our taxes that way. And a bar that priced beer like the government would have long since gone out of business.

    The 10th guy generally drinks for free while bragging about how he could buy the bar if he felt like it. And there’s a pretty good chance that the 9th guy is drinking for next to nothing too.

    The 7th and 8th guy — they’re the ones who really pay for all of the beer. They put up with it because they hope that someday they might claw their way to the top.

  5. Cara Ellison says:

    Bullshit. Bullshit bullshit bullshit. This is just wrong. You’re attempting to say that the rich are greedy, they pay for nothing, etc etc. Your class warfare crap doesn’t fly here in reality.

    • NoFreeBeer4Me says:

      It’s not class warfare it’s the truth. Warren Buffet pays less tax than his secretary. He has said so himself.

      Nobody likes paying taxes. “The rich” happen to be especially good at avoiding them. *I* don’t like paying taxes either. But I can recognize a broken system when I see one. And what is broken about our system isn’t what this silly story purports is broken.

      It’s a stretch but the story would be somewhat closer to reality if the middle class beer drinkers were buying beer for their poorer friends out of the kindness of their hearts and buying it for their rich buddies in appreciation for the jobs they provide.

  6. “Warren Buffet pays less tax than his secretary”… correct. What Buffett said is that he pays tax at a lower *percentage* rate than his secretary. The actual dollar amount he pays is orders of magnitude higher.

    btw, there is nothing to prohibit Buffett from compensating his secretary partially in stock or stock options, which would allow her to take advantage of the lower capital gain rate. I know executives who have done exactly that.

  7. ilovecress says:

    The thing is, I understand the anaolgy fine – but again, I’m not sure exactly what point it is that it is trying to make? That the nations highest earners can hold the USA to ransom by threatening to move overseas? This whole analogy supposes that there is a much nicer bar that the rich guy would like to drink in, rather than ‘bar America’. Like the rich guy is going to leave his high paying New York based job, and go and work in a paddy feild in China, so his tax percentage is lower. And even if he does – that high paying job will be filled by guy number 9.

  8. ilc…consider this example: a smart young person with an electrical engineering degree, some business experience and an MBA, and an idea. Also, this smart young person has Indian background. He isn’t rich yet, but plans to be. He can put his new company in the US, or in India, with which he is culturally familiar.

    Mightn’t his decision on location be based in substantial part on comparative tax and regulatory policy in the two countries.

  9. ilovecress says:

    David – Corporate tax rates though? Not personal income tax rates (I mean it might figure into his decision, but not as much as corporate tax rates.)

    In fact, might he not plough his excess earnings back into his company to save on the personal income tax?

    I’m not saying that it wouldn’t factor, but that other things would – which is why the example is laughably simple.

    Actually – does anyone have any information on whether or not ‘the rich’ are leaving the US due to punative tax rates?

  10. ilc…even if he reinvests money in the company and takes very little out as current compensation, when he ultimately *does* it out, it will be taxed as capital gains. And not all states, even currently, tax capital gains at a lower rate than ordinary income–Maryland, for example, taxes CG at the ordinary income rate. Note also that the founder/CEO needs to be concerned not only about his personal financial picture but about the attractiveness of the proposition to the key employees he hopes to bring on board.

    The US accounting policy of expensing options, which has been in place for several years now, is also a deterrent to some startups.

    Regarding corporate tax rates–the people who favor “soaking the rich” generally also favor high corporate income tax rates.

  11. ilovecress says:

    But you get my point about how absurdly over simplified it is?

    • simplified… but not overly so. The point is ultimately very simple – their greater incomes are not enough of a reason to soak them, and are no reason at all to resent them or blame them for how “unfair” the system is. They don’t go “overseas” in any great quantity when things get out of hand, unless by “overseas” you read “save rather than invest.” The bottom line is the same – if taxes get too high, those with the most to lose pull a lot of their money out of the economy. To call this “hold the USA to ransom” misses the point – because, again, it’s not the USA’s money to begin with. Their money is THEIRS. It is NOT the state’s. The state has no inherent claim to it, beyond the limited obligation that every citizen owes to the proper upkeep of the country’s infrastructure. You will find the 18 items that constitute this obligation outlines specifically in Section 8 of Article I of the Constitution – specifically outlined to curtail the natural greed of humans for other people’s stuff, which is especially dangerous when said humans are given the power to tax others.

  12. NoFreeBeer4Me says:

    The point of fairness is pretty simple too. It has nothing to do with “soaking” anyone.

    If roughly 30% is “fair” for me then why is it any less fair for WB?

    It isn’t. He even agrees. He’s a heck of a lot smarter about money than I am so I think I’ll take his word for it.

    If you’d like to argue that 20% for both of us would be better I’m not going to disagree. But a system where the rich are paying a *lower* rate than the middle class is just plain unfair.

  13. Cara Ellison says:

    Strawman argument. Warren Buffet was not elected as spokesperson for “rich people.” WB is vastly more wealthy than even most of the common rich.

    Get off the WB kick — he’s not the lone voice of reason telling you how the economy should be organized. He’s a lone liberal nutcake – of which there are many – who has a God Complex. Same with Bill Gates.

    Seriously, anyone who sits there and repeatedly cites one person as a representative for a whole group of people – rich people, poor people, black people, whatever – has absolutely no intellectual weight.

    Broaden your mind a bit. What about the dude making $1 million a year. Or who has amassed $100 million. There’s a huge scope of what the current admin thinks is “rich.”

    Fairness is a children’s concept. But I reject the notion that they’re paying less. I think most rich people are getting soaked. The rich people I know are not using $100 bills to light their cigars. They’re trying to keep some of what they’ve earned. And by the way, there’s a huge difference between income and wealth.

  14. NoFreeBeer4Me says:

    You’re a hoot! “lone liberal nutcake – of which there are many”. That’s priceless!

    You’d probably think that I’m “rich”. And you clearly think I’m a nutcake :)

    What’s so wrong with someone making $1,000,000 a year paying $350,000 in income tax? They still get to keep a pretty darn good sized stack of what they’ve earned. It’s a privilege to be in a position to pay such taxes.

  15. Cara Ellison says:

    I have no idea what your financial situation is and I don’t care.

    IT IS NOT THE GOVERNMENT’S MONEY. It does not belong to you or to me – it belongs to the people who earned it. That is the fundamental difference between us. I believe they should keep what they earn. You believe it is the government’s money to take and redistribute.

    That you would view it a “privilege” to pay such taxes is all I need to know about you.

    Taxes have become punitive. They are meant to punish the producers and reward the slothful.

  16. NoFreeBeer4Me says:

    If that were true then low income workers would be being taxed at a lower rate than high income workers.

    But, in fact, exactly the opposite is true.

    And, yes, it is a privilege to live in this country and contribute to the common good in proportion to my ability to do so. There is absolutely nothing wrong with that.

    I’d love to be making a million (or a billion) dollars a year and I’d be perfectly happy to be paying the same rate that I pay now, or even more, if I were to have that good fortune. I wouldn’t leave the country or create fewer jobs as a result of having more money either. Nope, I’d rejoice that I have a whole lot more money than I did before.

    • If that were true then low income workers would be being taxed at a lower rate than high income workers. But, in fact, exactly the opposite is true.

      You are in error. The marginal tax rate is lower at low income levels. Along with deductions and rebates, a low-income household usually pays nothing, while those at moderate or high incomes are on the hook in their place.

      Anyone who wishes to can always cut a check to the feds. Make it out to the US Treasury, fill in “federal debt reduction” in the memo, and mail it in. They’ll deposit it. You can also fill in a spot to check off on your tax returns, to reduce any refund you would get, for the same purpose. You’re golden.

  17. Cara Ellison says:

    Thank God you’re a small minority.

  18. Cara Ellison says:

    You can mail your gift to:

    Gifts to the United States
    U.S. Department of the Treasury
    Credit Accounting Branch
    3700 East-West Highway, Room 622D
    Hyattsville, MD 20782

    Please send me a photo of the cancelled check (blog dot cara no space ellison at gmail) so that I can post it and show that you are making these statements in good faith. Thank you!

  19. ilovecress says:

    IT IS NOT THE GOVERNMENT’S MONEY.

    Are you arguing that beer should be free? :-)

    • Cara Ellison says:

      Ah, ILC, you know I don’t. I am saying the government has no business in the beer business. It’s my money. If I want to spend it on hookers and blow, it’s my business (then they can arrest me for that.) But they can’t arrest me for wanting a nicer car or a nicer apartment.

      What I own is mine.

      • ilovecress says:

        But how does that work in practice? Are you advocating for no taxes at all? Then who pays for the roads, or defence, or any of the other things that you enjoy as being a part of a great society?

        Unless you are advocating for no taxes at all, then how the tax is split is still a conversation to have.

  20. ilovecress says:

    But moving on from the Warren Buffet strawman…..

    The key to this is the part about why the $20 discount was introduced. The reason for giving this discount should inform how it is distributed. In your example, the bar owner is just doing it to be nice…

    Try this version of the story:

    The guys are all drinking in the bar. However, the bar owner sees that due to the tough economic times, his patrons were finding it harder and harder to actually come to the bar. He decided to give something back to all his patrons, by reducing his prices by $20 (borrowing the shortfall from China for his son to pay back with interest, all the while claiming that he was going to reduce the amount of debt he was in – but, whatever….) His stated reasoning was that reducing the prices would help the wellbeing of all his patrons, and eventually allow them to spend more in his bar.

    He looked at all of his patrons, and saw that the first 9 of them were really struggling to get enough money together to pay for their beer, whereas the 10th guy still had a lot of money in savings, and wasn’t feeling the pinch as much. Whilst he wasn’t as well off as he was two years ago, hecould still comfortably afford the beer, and have money to spare.

    So he gave the breaks to the people for whom the discount would have the most effect.

    Now I know this is also grossly oversimplified, but I hope it explains why us demon liberals are against these tax cuts for the richest 2% from a more reasoned point of view…

    • He looked at all of his patrons, and saw that the first 9 of them were really struggling to get enough money together to pay for their beer, whereas the 10th guy still had a lot of money in savings, and wasn’t feeling the pinch as much. Whilst he wasn’t as well off as he was two years ago, he could still comfortably afford the beer, and have money to spare.

      So he gave the breaks to the people for whom the discount would have the most effect.

      Just getting back to this. I think I see what you’re trying to say, but I’m not sure how it helps.

      First, the bottom four patrons are already not paying anything for their beer. From the barman’s POV he can’t possibly give them a break, unless he pays them to come in the door.

      Second, by your own analogy, the bar owner has decided, consciously, to soak the guy whom he thinks can take it. This is the main protest we right-wing meanies have against the whole idea. It’s not the barman’s money to move around like that. He has no one to blame if said customer decides to stay home, or take his business elsewhere.

      Besides, in the original analgoy, the tenth guy was already subsidizing a major portion of the fun. He isn’t the problem here. Doing everything possible to drive his business away will ultimately close the bar – and then those nine struggling guys get no beer at all. (Then nobody’s happy – until the rich guy decides to open a bar himself.)

  21. ilovecress says:

    From the barman’s POV he can’t possibly give them a break, unless he pays them to come in the door.

    Like extending unemployment benefits? :-)

    Second, by your own analogy, the bar owner has decided, consciously, to soak the guy whom he thinks can take it.

    Absolutely. My point was that in order for everyone to be able to continue drinking there, someone had to be ‘soaked’, so he chose the person who could most afford it.

    Doing everything possible to drive his business away will ultimately close the bar – and then those nine struggling guys get no beer at all.

    Again, does this actually happen?

    And not to throw another spanner in the works, but the prices in the bar have been on sale for 10 years. What we’re doing here is talking about extending the beer sale for another 2 years, rather than putting the prices back to 2002 levels.

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