Tuesday, April 03, 2007

How income tax works?

The following expanation of how income tax works comes from Manuel Lora over at Vangardist.org

Sometimes politicians, journalists and others exclaim; "It's just a tax cut for the rich!" and it is just accepted to be fact. But what does that really mean? Just in case you are not completely clear on this issue, I hope the following will help. Please read it carefully.

Let's put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for dinner 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 ate dinner in the restaurant 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 meal by $20." Dinner 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 eat 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 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, 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 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. 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 me!"

"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 dinner, so the nine sat down and ate 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 eating overseas where the atmosphere is somewhat friendlier.


Anonymous said...

I must admit, if the point of this story was to amuse, it did the job. However, this story is very flawed in its understanding. Much of the time, it is not poorer tax payers complaining about getting money back, it is the wealthy. It is the wealthy that complain most about taxes, as they do not see how they benefit by them. Their tax money is used to help out the poorer tax payers, thus they do not feel they see any of the return from their taxes. Using their influence, they pursuade the government to refund more and more taxes, undermining the system put in place to help those who do not have as much. So instead of the owner saying he would reduce the bill, the richest man said he would not come anymore if the owner did not reduce the bill as "the 10th man was paying the most of it."

Anonymous said...

To 12:21PM: The original post was not eamnt to be funny and it was no sociology lesson. I'm guessing you haven't taken micro and macro economics, or you would've known that the example is a true model of how our tax system works. In response to the last sentence of your post: if "the 10th man didn't frequent that restaurant anymore" the restaurant would be out of business: lots of people would lose their jobs, the prices of goods would increase because there would be less demand, I could go on and on. That's how a free market society works. If you don't like it, move to Cuba.

Jim Fedako said...

The previous post (12:21) is full of non sequiturs - leaps in logic for a humorous effect, though I bet the 12:21 was not trying to be funny.

SocietyVs said...

"That's how a free market society works. If you don't like it, move to Cuba." (Anon)

Why Cuba exactly? Why move also? This is America can't we learn to get along even while we disagree? Also the people that complain most about taxes are working poor (middle class in minimum wages). They always want more than what they actually have - as taxes taken relogate them to a status they can't afford to buy a house. But that's the tax system and I personally enjoy the fact my taxes do go to some great things like roads.