The Truth About How The Income Tax System Works
This article starts a new, every-four-year—before the presidential election—tradition for this column. Actually, this article (a big, long quote) first appeared in this column in October 2003. I was flooded with requests for copies, the last one—would you believe—about six months ago. Enjoy what follows. Then pass it on to your friends, and save copies to give to your kids and grandkids.
I did not write it. I wish I had. The source is T. Davies, Professor of Accounting at the University of South Dakota School of Business, who told me he got it from a student. So, the real author remains unknown. Here’s the article:
“Let’s put [income] 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. “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. If they subtracted that from everybody’s share, then the fifth man and the sixth man would end up being paid to eat their meals.
“So the restaurant owner suggested that it would be fair to reduce each man’s bill by the same amount, and he proceeded to work out the amounts each should pay. The fifth man now paid nothing, the sixth paid $2, the seventh paid $5, the eight 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.
“However, once outside the restaurant, the men began to compare their savings. ‘I only got a dollar out of the $20!’ declared the sixth man, pointing 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 (or, in the real world, he took his business out of the country), so the nine sat down and ate without him. When it came time to pay the bill, they discovered, a little late, what was very im-portant. They were $52 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 or 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!” The end!
Now, I have a favor to ask of you: Please send a copy of this article to every politician you know who could influence income tax legislation. Make sure you include both presidential candidates.
The sad part is that we—professional tax practitioners—have not figured out how to beat the income tax. Earn and you pay; earn more and you pay more.