Bar Stool Economics

I received the following story as an email forward. My comments follow after the “lesson.”

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Bar Stool Economics

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 paid $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.

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That cute tale is attributed to David R. Kamerschen, Ph.D., Professor of Economics, University of Georgia. However, there are a few things wrong.

First, according to his website, “…Dr. Kamerschen is NOT the author of Tax Cuts: A Simple Lesson in Economics. ” The email entitled Bar Stool Economics can be found online as Tax Cuts… Why masquerade as a PhD in Economics? If the author is credible, publish your beliefs and let the community vet the document. This “lesson in economics” probably wasn’t written by a PhD in Economics. I have to question why the author would clamor to Kamerschen for clout—definitely shady.

Second, the 59% number is bogus. Where does 59% come from? Income tax rates in the States top out at 35%. Capital gains taxes in USA top out at 28% and are normally 15%. Estate taxes are around 35% as well. The highest number I found said estate taxes are 55%.

I know that one of the world’s richest men, Warren Buffett, openly admits to paying a lower tax rate, 17%, than his secretary (33%). All that without a tax advisor. Imagine what you could do if you got a good accountant? Buffett has angered other affluent people by challenging them to admit their tax rate is lower than middle Americans. One of the top three richest people, Warren Buffett, is not paying 59% either; I think it is safe to say the bar stool economics fails the fact check.

What tax or combination of taxes would equate to 59% of the tab? So 59% is not based on tax rate, so maybe it is the tax burden. Looking into that I found several good articles on the distribution of wealth in the US, see Google answers, Wikipedia, and a sociology page from UCSC. From the hive mind:

“The data shows the progressive tax structure of the U.S. federal income tax system on individuals that reduces the tax incidence of people with smaller incomes, as they shift the incidence disproportionately to those with higher incomes – the top 0.1% of taxpayers by income pay 17.4% of federal income taxes (earning 9.1% of the income), the top 1% with gross income of $328,049 or more pay 36.9% (earning 19%), the top 5% with gross income of $137,056 or more pay 57.1% (earning 33.4%), and the bottom 50% with gross income of $30,122 or less pay 3.3% (earning 13.4%).[9][10] If the federal taxation rate is compared with the wealth distribution rate, the net wealth (not only income but also including real estate, cars, house, stocks, etc) distribution of the United States does almost coincide with the share of income tax – the top 1% pay 36.9% of federal tax (wealth 32.7%), the top 5% pay 57.1% (wealth 57.2%), top 10% pay 68% (wealth 69.8%), and the bottom 50% pay 3.3% (wealth 2.8%).[11] (Look under the Tax distribution heading for this information.)

Still no 59%! And, although not much, the bottom four drinkers from the story would have to pay something.

Third, the United States has some of the lowest taxes in the world, so rich people fleeing is not as great a concern. If people are leaving the US for tax breaks, they’re leaving any country with taxes. If you can get past the impossible immigration laws and handle the radically different culture, UAE, would be perfect for those seeking to escape taxes.

Fourth, the numbers may show that the wealthy have to pay a lot, but rich people manipulate the system. There are a lot of ways to lower your tax burden, from transferring ownership to moving wealth into companies, charities, IRAs, … Chances are, the effective methods aren’t well known so I won’t even conjecture how people perform miracles with disappearing money. Whether they reduce their income or the amount of tax they have to pay, rich people can afford to find loopholes and make significant savings.

The above email forward has many flaws, but I believe it makes a good point: our system is complicated and unfair. If I’ve missed something, I’d love to hear about it.

I’d like to note that I do not enjoy paying taxes; even as a relatively poor person, I feel I pay too much—especially considering what I get from the government. I would love a massive overhaul of the system so that everyone could pay less taxes with simplified rules.