On taxes and barstool economics

A friend of mine posted a story on Facebook that purports to explain income taxes, with beer. This led to a long discussion largely in support of its conservative message. I've found it on a few forums, purportedly by David R. Kamerschen, Ph.D. Professor of Economics University of Georgia. Here it is:

Our Tax System, Explained in 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 on 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 percent, 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 pay $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,”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 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 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.

Ok. There are several problems with this.

The first problem, when you try to apply it to the national tax system, is that the bartender isn't giving anybody a break. Instead, he's increasing his rates. And we're all demanding tax relief in the face of increased spending! So who's paying for the extra $700Bn bailout, or the $600Bn+ we've spent in Iraq? If our government were indeed shrinking, this might be an apt metaphor--but it's not. It's growing. The question isn't "how do we split the savings fairly," it's "who should pay for the increased cost?"

Secondly, where would the rich guy go drink? Of the developed countries, we have some of the most advantageous arrangements out there for the wealthy. Much of Europe has a more socialist system, and tax higher incomes much more than we do. China? You run the risk of being nationalized. I guess India might be a good place, if you really wanted to be a cheapskate and keep your relative wealth intact. Or Dubai.

A counterpoint

What we choose to tax says a lot about who we are and what we value. Our income tax system is progressive, because it taxes higher incomes at a higher rate, and below a certain level, there's no tax at all. A Sales tax isn't particularly progressive or regressive--it just taxes consumption, which in this age of waste probably isn't a bad thing. A lottery is regressive, since lower income people tend to see them as their only path to success.

But there are other taxes that have a much bigger impact on our society than these. Payroll taxes are regressive, since they tax up to a certain level, and then no more. Business and Occupation taxes (which we have here in Washington) penalize small businesses that do not encompass their entire supply chain under a single corporate entity. Capital Gains taxes tax profits realized from changes in the value of something over the time you've owned it.

I'd argue that Washington State has a strong economy in spite of its tax policy, not because of it. Our strong economy is due to our abundance of natural resources such as hydro-power, agriculture, and natural beauty that makes it a place creative and entrepreneurial people want to live.

So what would I do? I'd look at the larger system, and the larger problems we face. We have a lot of unemployed/underemployed people. It's very expensive to hire people, because of payroll taxes and the heavy burden of health insurance. Instead of taxing those things, we should eliminate the payroll tax and make it easier for businesses to hire good people. And provide health care to lower the burden on our businesses, and good education so that we have talent worthy of hiring. The current system is stacked in favor of large corporations who have the margins to support funding these things--but these same corporations have shown no sense of responsibility in doing so, and would sooner chase lower wages anywhere else in the world to improve their bottom line.

We also are facing major climate issues, national insecurity due to dependence on foreign oil, and congested traffic. All of these issues would be helped with a strong consumption tax on oil. We have a gas tax, but it's nowhere near enough to encourage people to get out of their cars. Forget cap and trade policies--we need a carbon tax.

So I'd probably keep the current sales and income taxes, but change the tax policy away from penalizing those who provide good jobs here, and towards those who consume, exploit, and waste our natural resources.