The Taxman cometh (NS Canada Old Forum)

Title: The Taxman cometh

Redundancies - January 31, 2007 02:47 PM (GMT)

Saw this piece on snopes.com yesterday and started thinking about taxes. This piece presents the tax system in the form of a parable, but I think there are a few things it gets wrong...

QUOTE

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!

And that, boys and girls, journalists and college instructors, is how the 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.

Where would that leave the rest? Unfortunately, most taxing authorities anywhere cannot seem to grasp this rather straightforward logic!

I have a couple problems with this logic. First, the statement made at the end that high taxes will somehow deter people from trying to make as much money as possible. In fact the opposite is true--you want to net as much money as you can, so you gross more (and find tax loopholes) to make your net gains higher. I know in my case, I figure my income as my "net" anyway--I know my annual salary but I'd have to look at my pay stub to see exactly how much I gross every half month. Conversely, I *know* how much I net each pay period.

Second, the logic is flawed in that it implies that everyone gets the same "dinner". What they don't tell you is that the four guys who pay nothing are getting bread and water, whereas the guy who pays the $59 out of the $100 is getting filet mignon. (to continue the analogy)

This also makes me think about debates between a flat tax and a progressive tax. Proponents of a flat tax figure it's more "fair"--everyone pays a share relative to their income--and point out things like "1% of the country has to deal with 50% of the tax burden" (data varies, I'm using an example). What they don't point out is that that same 1% usually controls more than 50% of the wealth in the country. Sometimes a lot more.

Besides, it's a lot easier for someone making, say, $1 million a year to still live comfortably even with a high tax rate, whereas a person making $25,000 a year would need a low rate to be able to continue to have a roof over their head and food on their table. And the fact is that richer folks benefit more from living in this society--people say high tax rates are a "punishment" for making more money, I say it's extra payment for a service (the economy, essentially) which allows them to make a lot more money than others.

Thoughts?

Lorelai County - January 31, 2007 07:18 PM (GMT)

Very good points you made out. Especially with your three statements after the first one I do absolutely agree.

In my opinion this example is not sufficient. It simplifies too much a very complex topic and does not reflect the tax problematic in the real world. It’s maybe good enough to explain the rivalry between governments with different tax rates (location competition).
If the table represents a nation or at least an entity with fiscal sovereignty, there must be other tables around. All persons are able to go to a table, which brings themselves the most benefit (has the best tax rates for them). If there are no other tables around nobody will be able to change and not to pay is automatically fiscal evasion.
(Ironically moving to another table is bound with expenditures and therefore changing to the best table is mostly a privilege of the rich ones.)

> (Just my theory, can be totally wrong)
To the first statement: Maybe a higher tax rate will deter people from generating more income in case of progressive taxation. The more you earn the more you have to give a way. Therefore an additional unit of work to earn money brings less benefit compared to the earning unit before. Compared to other activities the work respectively earning-unit will lose constantly benefit. Other activities with constant benefit or benefit not coupled to the progressive taxation will be therefore more likely the much richer a person is. :shrug:
(I think this has something to do with the microeconomic concept of marginal benefits and Opportunity costs. If I’m wrong please correct me, it’s just so long ago I had such stuff in lecture.)
However even this is too simple, because we should not look only at the income. The more a person can earn the likely he/she can build up assets and savings. Asset & savings are somehow an investment in future income and brings other huge benefits. So I think even with progressive taxation the marginal benefit effect is negligible. :shrug: :shrug:
What do you think?

canada6 - January 31, 2007 07:47 PM (GMT)

I have a layman's understanding of economics, but I think the analogy used in the article is inapt. Income taxes are paid as a percentage of taxable income and a restaurant bill is a fixed price for services rendered.

But both of you have made some great points.

As a rule I don't agree with flat taxes, but they are often a great device for creating economic growth in the right circumstances. Several Eastern European nations have pioneered their use with results ranging from mixed to very positive.

I personally am involved with a small Portuguese political movement (hoping one day to create the first centrist political party in Portugal) that recently passed a motion supporting flat taxes.
Other members in the movement see it as a useful political tool though, I don't necessarily agree with them. First of all it really isn't possible because of the budgetary discipline that the EU's mandates for nations in the Euro-zone. The EU's policy simply doesn't allow us at the moment to increase our deficit, so a flat tax is realistically impossible and undesirable.

Taxes cover many things.

They cover social spending that the wealthy might not use, but on the other hand they finance protection of private property that the poor will less often require if ever at all.

To uphold principles such as equality of opportunity and social cohesion, that cannot be achieved by way of any private charity, it's common sense that a greater tax burden for these aims, should tend to fall progressively upon whom will suffer the least with it.

Capitalism as the reigning social model of property and trade, is not optimal as a system. Progressive taxation is one of many subtle forms of ameliorating the imperfect byproducts of capitalism, in order to maintain a sustainable social cohesion (population living peacefully within a nation under rule of law).

I'm confident that there is not one single argument for individual liberty that I would disagree with. On the other hand, I have yet to hear one single argument for denying individuals a fair opportunity through enabling state distributive measures and basic tax-payer supported public services.

Redundancies - January 31, 2007 08:55 PM (GMT)

QUOTE

Maybe a higher tax rate will deter people from generating more income in case of progressive taxation. The more you earn the more you have to give a way. Therefore an additional unit of work to earn money brings less benefit compared to the earning unit before.

Marginal Returns, I believe, is the rule you're quoting here. While it's true, I think that for most owner-types, their "units of work" do not increase as their wealth potential goes up--they hire others to add in their own units of work, and the cost is monetary rather than in time and ability of the owner.

So if I'm the owner of Red's Pizzeria, and I want to open a new store, I hire folks to run that store. I make more in gross sales, and if that surpasses the salary of my new employees(plus all other associated expenses), I've made more money without doing any additional units of work.

Also relevant may be simple pay raises. I recently got a raise for doing my job well--I'm not doing any more work now that I was three months ago but my pay is increased, beyond what inflation would bring.

So I think you can definitely have incentive to make more money without actually requiring additional work to be done.

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