Consider the Evidence

A parable about the virtue of low tax rates for the rich has circulated on the web for a number of years. It apparently originated as a letter to the editor in the Chicago Tribune in 2001. Here is a recent version:

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 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 bar, 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, 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.

The parable is misleading in several ways. (For more commentary see this, this, and this.)

First, though it doesn’t matter much, the numbers aren’t right. See here (table 1b) for the actual shares of federal taxes paid by various groups.

Second, and more important, if the government (the bar owner in the story) reduces tax rates (the price of beer) it usually must do one of two things to compensate for the lost revenues. One option is to reduce its expenditures. In the context of the parable, this means the bar owner lays off a bartender or a bouncer; or perhaps she has the bar cleaned less often or forgoes needed repairs. Some customers won’t care, but others will find the bar a less attractive place to spend time in. They might be happy to pay a little more for beer if it means faster service, nicer surroundings, and fewer bar fights. The same applies to government services such as police, military, schools, roads, bridges, subways, and parks.

The other option is that the government borrows money to finance the tax rate (beer price) reduction. If the bar owner does this and it results in a substantial debt, as was the case for our federal government in the 1980s and in the 2000s, a larger share of her revenues will go to her lenders as interest payments. Eventually she may decide it makes sense to raise prices (taxes) again, as did the first president George Bush in the early 1990s — even though it meant reneging on his “read my lips: no new taxes” pledge.

But set these issues aside. The most important point is this:

The claim made by proponents of equal-percentage tax cuts is that the rich man (the tenth) will stop coming to the bar and paying for a large share of the tab if he doesn’t get the same percentage price (tax) reduction as the others. (Forget about the others beating him up; that’s a distraction from the real point the parable aims to make.) This could conceivably be true. Or it might not be. Many advocates of tax cuts for the affluent believe it’s true. But that doesn’t mean they’re correct.

In my view it’s equally plausible to hypothesize that the tenth man would keep showing up even if he were asked to continue paying $59 — in other words, even if the others get a beer price (tax) cut while he doesn’t. After all, he wouldn’t be paying any more than before. And he could probably afford it; according to Congressional Budget Office data — see table 1c here — average pretax income among households in the top tenth was $340,000 as of 2005.

How the tenth man will react is an empirical question. There’s some discussion of relevant evidence in previous posts of mine here, here, and here.

Stories resonate with us far more than do impersonal statistics. But in some instances, such as this one, the reason a story resonates is simply that it affirms prior beliefs, rather than because it offers genuine insight.