There’s an old tax parable that is redoing the rounds on my newsfeed (again). So I’m re-telling my version of the story (again).

Ten men go out for a beer….

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 ball. “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 men would 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? 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 a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

• And so the fifth man, like the first four, now paid nothing (100% saving).
• The sixth now paid $2 instead of $3 (33% saving).
• The seventh now paid $5 instead of $7 (28% saving).
• The eighth now paid $9 instead of $12 (25% saving).
• The ninth now paid $14 instead of $18 (22% saving).
• The tenth now paid $49 instead of $59 (16% saving).
• Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, 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 a dollar too. It’s unfair that he got ten times more benefit than me!”

“That’s true!” shouted the seventh man. “Why should he get $10 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. This new tax 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 their 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 government ministers, is how our tax system works. The people who already pay the highest taxes will naturally 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.

Sounds reasonable, right?

Unfortunately, this kind of parable tends to oversimplify things, even if it’s a very convincing style of Econ101 analysis. And if you’re interested in some of the problems with Econ101-style analysis, then I strongly recommend this blog post by Noah Smith: 101ism in action: minimum wage edition.

The trouble is that economies are not one-liners. They are ecosystems – and you can’t talk about taxation and spending without talking about “where did the money come from”.

So let me attempt to re-tell that parable.

Ten Men Walk Into A Bar…And One Of Them Owns The Brewery

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.

There are many reasons why the richest man agreed to pay the bulk of the bill, but the important one is that he owned the only brewery in town, and the barman would buy all the beer from him. The seventh, eighth and ninth men all worked in the brewery, and earned salaries according to their skill level. The sixth and fifth men owned farms which supplied the hops – although they didn’t earn particularly well, because the brewery was the sole buyer and it negotiated quite stiff rates. The remaining four men were farm labourers who earned enough to eat, but not enough to drink.

The way that the brewery man saw it: the drinks must flow in order for the barman to be in business and sell the beer that the brewery produced.

The ten men were also very protective of their beer industry, and would run any newcomers out of town. This meant that the ten men were the only real regulars at the bar, and the only real source of its income.

So to keep the bar in business and the town happy and the drinks flowing, the richer men would pick up most of the tab. And they were (relatively) happy to do it because most of the bill would end up back in the brewery man’s hands anyway.

So the ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the barman threw them a curve ball. “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 men would now cost just $80. What he didn’t say is that there had been a bumper season of barley, so the brewery had produced its beer fairly cheaply that month – and the brewery owner had offered the barman a substantial discount on the beer in order to get rid of it.

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? 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 a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

• And so the fifth man, like the first four, now paid nothing (100% saving).
• The sixth now paid $2 instead of $3 (33% saving).
• The seventh now paid $5 instead of $7 (28% saving).
• The eighth now paid $9 instead of $12 (25% saving).
• The ninth now paid $14 instead of $18 (22% saving).
• The tenth now paid $49 instead of $59 (16% saving).
• Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, 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 a dollar too. It’s unfair that he got ten times more benefit than me!”

“That’s true!” shouted the seventh man. “Why should he get $10 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. This new tax system exploits the poor!”

In their rage, the nine men decided to boycott the bar.

The next night only the tenth man showed up for drinks so he sat down and had the beer on his own. But when it came time to pay the bill, he discovered something important. 90% of the beer had gone unsold, and the barman was threatening to return the stock to him in the morning. And if the situation remained unchanged, then the barman was planning to shut up shop, and the brewery would have to close, and then everyone would be without jobs.

And that, boys and girls, journalists and government ministers, is how our economy works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction, but the wealthy also have a vested interest in keeping consumers at the table. That consumption drives the economy and gives value to the businesses that they own. And the hard truth is: if anyone decides to leave the table, then it’s likely that everyone will lose. And it’s really hard to keep everyone happy.

#itscomplicated

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.