Barstool Economics: Taxes Made Simple
I'm sure many of you have run across this simplified tax analogy before, but it was new to me. Although it's not a perfect match to our system magnitude-wise, the core of the example rings true -- in very simple terms. The author of this piece remains a mystery, but that's kind of irrelevant...to me at least. How Taxes Work . . .
This is a VERY simple way to understand the tax laws. Read on— it does make you think!!
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 fifth would pay $1, the sixth would pay $3, the seventh $7, the eighth $12, the ninth $18, and the tenth man— the richest — would pay $59.
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 (in tax language a tax cut).
"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 $80.00.
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 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 paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59. 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 who pointed to the tenth. "But he got $7!"
"Yeah, that's right," exclaimed the fifth man, "I only saved a dollar,too . . . It's unfair that he got seven times more than me!".
"That's true!" shouted the seventh man, "why should he get $7 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 he 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, a little late what was very important. They were FIFTY-TWO DOLLARS short of paying the bill! Imagine that!
This is a VERY simple way to understand the tax laws. Read on
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 fifth would pay $1, the sixth would pay $3, the seventh $7, the eighth $12, the ninth $18, and the tenth man
That's what they decided to do. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement
"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 $80.00.
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 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 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 paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59. 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 who pointed to the tenth. "But he got $7!"
"Yeah, that's right," exclaimed the fifth man, "I only saved a dollar,
"That's true!" shouted the seventh man, "why should he get $7 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 he 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, a little late what was very important. They were FIFTY-TWO DOLLARS short of paying the bill! Imagine that!
I also found this comment interesting on another blog discussing Barstool Economics:
Another interesting mathematical fact is how the share of the bill increased for the top "payers" even though they received a greater total discount.
the percentage of the bill for each "payer" at the $100 bill and the $80 bill.
1 - 00.0% 00.0%
2 - 00.0% 00.0%
3 - 00.0% 00.0%
4 - 00.0% 00.0%
5 - 01.0% 00.0%
6 - 03.0% 02.5%
7 - 07.0% 06.3%
8 - 12.0% 11.3%
9 - 18.0% 17.5%
10- 59.0% 61.3%"
the percentage of the bill for each "payer" at the $100 bill and the $80 bill.
1 - 00.0% 00.0%
2 - 00.0% 00.0%
3 - 00.0% 00.0%
4 - 00.0% 00.0%
5 - 01.0% 00.0%
6 - 03.0% 02.5%
7 - 07.0% 06.3%
8 - 12.0% 11.3%
9 - 18.0% 17.5%
10- 59.0% 61.3%"
Labels: barstool economics, tax cuts, taxes
Posted by VC Dan | 2/03/2008
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Comments (5)
Interesting analogy. I hadn't seen it before. It sounds plausible, but I think it may be a little too simplified to actually say much about our current tax system. No too long ago I heard Warren Buffet say in an interview with Fox Business that his own effective tax rate was around 18% of his income. And when he compared it to the secretaries in his office, he found that their tax rates were actually higher than his.
Qian, I could be wrong, but I'm guessing Warren's secretary is one of the highest paid secretaries on the planet. That would put her in a pretty high tax bracket. I'd also guess that most of Warren's annual returns come from investments, rather than income. As a result, his blended tax rate would be close to the rate on capital gains (typically lower than income tax rates).
This barstool analogy doesn't really get into the policies behind income tax vs. capital gains tax (typically created through the use of investing after-tax dollars, encourages investment), so I'll leave that discussion for another time.
As for Buffet's claim about his secretary, I could believe it. She's probably doing quite well. I'd also bet that Buffet pays significantly more absolute dollars than his secretary for roughly the same amount of government services.
I love the story. I didn't know how to explain it, but giving "rebates" to people who didn't pay taxes never will feel right.
Also, if you want a good read about Warren Buffet and his secretary's taxes you should read Mark Cuban's blog post about it: http://www.blogmaverick.com/2007/12/11/warren-buffett-taxes-and-the-presidency/
Dan, I'm sure you might be right, but Buffet is also known to be quite the bargain hunter, so it wouldn't surprise me if he doesn't pay significantly above market rate to his secretaries. You are of course quite right about the fact that his income is largely capital gains and that would lower his effective rate. I also won't take your bet since 18% of however many billions Warren earned is certainly orders of magnitudes more than 25-35% of let's say 100K or so that his secretary earned. I completely agree that the wealthy in this country bear a far greater share of the tax burden than the government services they receive would call for. And given that the taxation is already done in a way that is not tied to how much services each person receives, there's no reason why a tax-cut needs be exactly proportional either.
I think an important question is whether a progressive tax structure is fair. In the same interview, Buffet argued that it is. He said that if he had been born in another country, given the same talents and hard work, he would not be where he is today, and to have the opportunities that America affords and the socioeconomic system that makes it possible for individuals to accumulate great wealth, it is not too much to ask that those who have benefited the most from the system give back the most in return. I kind of like his view because I think there's more to the American government than just a set of services. It is the embodiment of an ideal and a philosophy that has created the most powerful economic engine in the history of the world. The way the government spends our tax dollars isn't always good or efficient. But I think it's still the best in the world and well worth the money because it gets so many things basically right. If I ever have the good fortune to become rich through hard work and some luck, I would cherish the opportunity to pay a bigger share of taxes in order to make sure that this great system will be sustained. And I wouldn't trade places with someone who's not rich even if I never got another tax cut ever again. :)
great comments guys...I guess political topics bring more controversy than my typical venture/startup fare...maybe I should bring up religion next ;-)
Qian: I find it interesting that you use language like "it is not too much to ask" and "I would cherish the opportunity to pay a bigger share"; when the opportunity to pay a bigger share is always there for you to do so; regardless of tax laws. However, we're not talking about whether you can stick your hand in your own pocket to support a system you believe in. We're talking about a mob being allowed to stick their hands in your pocket regardless of your beliefs -- because they outnumber you and the government is their "muscle".
One might say that is the reality of a successful entrepreneur living in a democracy, but I'm not sure it's a necessary or healthy reality. See Bastiat's "The Law" for a detailed review of what happens when the law is used to abridge your person, liberty and property; rather than protect them.
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