Barstool Economics...

a lesson for all of us.

I can still remember the maximum 98% income tax (83% +15% investment income surcharge) borne by someone with investment income in the UK, some 30 years ago (not sure about the current tax situation).

Just imagine if you were already earning that kind of income, and for every additional Pound Sterling you earn, you retain only 2 pence! Would you have any incentive to invest to earn more?

In Malaysia, recently we had a rebate of Rm625 for those who owned cars with engine capacity up to 2,000 cc, soon after the price of crude oil skyrocketed. A friend would complained without fail each time this topic crops up, that it was unfair because those who could afford BMW 320i and Mercedes C200 Kompressor (costing over Rm200,000 each) were still eligible. He forgot the fact that having paid that kind of price in Malaysia, the owner would have paid at least tens of thousands in excise duties to the government.

The reason I mentioned these two examples is because of the following classic example by a Professor in Economics:

Barstool 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 saving,' 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 adollar, 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.

David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia