Tuesday, December 15, 2009

How the tax system works - the Irish edition

Here is a revision of this little parable using the most recently available Irish data (2006).

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 five men (the poorest) would pay nothing. Nada
The sixth would pay €1.
The seventh would pay €3.
The eighth would pay €9.
The ninth would pay €21.
The tenth man (the richest) would pay €66.

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 total.

The group still wanted to pay their bill the way we pay our taxes so the first five men were unaffected. They would still drink for free. But what about the other five men - the paying customers? How could they divide the €20 windfall so that everyone would get his fair share? They realised that €20 divided by five is €4. But if they subtracted that from everybody's share, then the sixth and seventh 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 sixth man, like the first five, now paid nothing (a 100% saving).
The seventh now paid €2 instead of €3 (a 33%saving).
The eighth now pay €6 instead of €9 (a 33%saving).
The ninth now paid €16 instead of €21 (a 23% saving).
The tenth now paid €56 instead of €66 (a 15% saving).

Each of the five was better off than before. And the first five continued to drink for free. But once outside the bar, the men began to compare their savings.

"I only got a euro out of the €20," declared the seventh man. He pointed to the tenth man, "but he got €10!"

"Yeah, that's right," exclaimed the sixth man. "I only saved a euro, too. It's unfair that he got ten times more than I!"

"That's true!!" shouted the eighth man. "Why should he get €10 back when I got only three? The wealthy get all the breaks!"

"Wait a minute," yelled the first five 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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