Bar Tabs and Tax Cuts

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.

16 thoughts on “Bar Tabs and Tax Cuts

  1. I agree that the parable is misleading in several ways. On that topic, I just posted an updated response to Rush Limbaugh’s article “Only the Rich Pay Taxes” at http://home.att.net/~rdavis2/richpay.html. Regarding the proposition that all taxpayers should get the same percentage price (tax) reduction, I think that’s fine as long as we can afford the tax cut. However, as the graph at this link shows, the U.S. Budget is projecting huge deficits in the coming decades. Hence, the Bush tax cuts were more of a tax deferment than a tax cut. In addition, the Bush tax cuts were anything but a equitable tax cut that reduced all brackets by the same percentage. In any event, when and if tax hikes do become necessary, I believe that they will have to be concentrated on higher-wage earners who can best afford them.

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  3. The highest paid guy at the office got both the biggest raise AND the biggest tax cut. The raise was so big that his big tax cut couldn’t keep up and he actually paid a bit more on April 15th.
    This really pissed him off, so he started telling everybody about how unreasonable his tax burden is.

    Biggest raise AND biggest tax cut. And complaining about it.

    That’s America’s rich for you.

  4. The point that I get out of the story is that people that aspire to nothing, complain about having nothing. If they are tired of being poor, do something about it! I did.

    Rich people have more opportunities, granted, but if you want something work for it and get it.

    If we only paid taxes on what we spend, there are a lot of “poor” people that would be paying taxes on their big screens, gaming consoles, fancy cars, and such. If they put the money they spend on these types of luxury items to better use, then they would have more.

    It should not be my responsibility to pay for someone who is not willing to make an efort to make it on their own. And before you go off on me about the elderly and disabled, They CANNOT do for themselves, and I consider that a totally different matter.

    Regards,

    Clint

  5. The parable is only misleading if you do not have basic math and reasoning skills, and do not understand percentages. It is very analogous to how America is taxed.

    Similarly, liberals often make the bogus claim that there are more people in poverty now than ten years ago. (Even though the percentage of the population in poverty has decreased). These people do not understand basic statistics. Yes, there are 1000s of times more people in poverty now than in the 1400s, because the population has increased.

  6. Hi Lane, your comment…

    “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.”

    …assumes that taxes and the economy are a zero-sum game, and that if beer prices in our parable are lowered, there’s a piper to be paid usually by cutting expenses (e.g., layoffs) or borrowing.

    I respectfully disagree – lowering beer prices could just as easily result in stimulating business for the bar, creating additional revenue.

  7. This response is way late, but I just found my way to this article.

    I agree the parable is missleading in the sense that that last paragraph I think misses the point of the story. My sister is one of those people who enjoys the benifits our country provides to people, yet she complains about higher tax rates on the middle class and tax cuts for the wealthy. When I tried explaining to her that although the wealthy get tax cuts they still pay most of the tab she reacted the way alot of people do, she said well they can afford it. A tax cut does equal less government services, but a lack of tax cuts mean someone is footing most of the bill for us, and regardless of wether or not they can afford it I don’t think it’s fair for them.

  8. Pingback: JABbering Stooge :: So, Ten Men Walk Into a Diner*… :: December :: 2008

  9. I appreciate your comments here and am posting this because I got fed up with seeing the bar/tax analysis & thought a different response was appropriate.

    First off, they keep drinking here because we’ve got the best beer on the planet. Secondly, the reason they are all drinking together in the first place is because they work together. In fact, they own the bar. The 10th man is the bar manager and he employs the other nine. The next three are the successive supervisors in the bar who are paid according to 10’s perception of their worth (i.e. shifts managed, ability to get customers to buy more beer, or maybe just because he likes one better than the other managers). The bottom 4 are the manual labor (bartenders, waiters, busboys), and the middle 2 are the manual laborers who got bonuses for productivity. (For the sake of discussion, let’s just skip the question about drinking at work and lost productivity due to hangovers)

    The fact is, none of them would have any money for beer if they weren’t all working together to produce the wealth that enables them to buy the beer in the first place. Admittedly, you could probably lose one or two of the manual laborers and still have the business function but total productivity would go down as would their collective wealth.

    The other aspect of this analysis is to what extent should each benefit from a reduced price of beer? The fact is, they aren’t always able to go to the bar together, at the same time. If the manager or some of the supervisors aren’t there they can’t always afford as much beer as they might want to drink. #10, the bar manager can afford all the beer he wants anyway so a price reduction won’t significantly impact his ability to satisfy his desire for beer. The 3 supervisors are probably in a similar position although it is possible that one of them might be in a position that a reduction in the price of beer would entice him to occasionally buy another one. The bottom six however can’t afford nearly as much beer as they would like. If the price was reduced they would almost always buy more beer. This would increase the profitability of the bar and ultimately make them all richer. In fact, the manager and supervisors would benefit the most since they collect a higher proportion of the profits of the bar in the first place.

    In other words, if you reduce the price of beer for the bottom six, the top four get richer.

  10. I’m just venturing out into the world of politics.
    I think DBJ was totally right when he said “lowering beer prices could just as easily result in stimulating business for the bar, creating additional revenue.”

    If the government was to cut taxes by a small percentage, people would be coming home with just a little bit more money in their pockets. As a college student, I know that an extra 5 dollars on my paycheck would be gone before I had time to even realize that it was there.
    Lowering the price of the beer could boost morale among the men causing the men to tell other friend and family about the great service at the bar, or the great manager.

    What the government loses in direct income taxes, they could make up for on sales tax or other areas. Just some thoughts.

  11. lane.. your rebuttal is lame… How about the owner didn’t feel the need to maintain such a high profit?.. No service reductions.. no quality reduction .. just a step down in profits?

  12. Ok, so what’s the alternative? Please suggest another way to divide the barman’s price reduction that is “fairer”. Lane’s statement that the richest man was happy to pay $59 of a $100 bill, and will therefore pay $59 of a $80 bill is very suspect. It is “fair” that he gets a 14.75% increase (as he pays 73.75% of the total bill as opposed to 59%)? If he does pay this bill, what happens when the barman stops the discount? Does he then have to pay $73.75 of the $100 bill?

  13. OK, lets go for a real life situation instead…. a salesman on commission, living in CA makes $250K per year. Believe it or not, a middle class living in San Francisco or Los Angeles. Taxes at the State and Federal level now exceed 52% for the salesman. Add property taxes for an average home and his rate is north of 56%. He has two kids that play sports. Sales is a high risk and hard work profession. He now decides that he would rather watch his kids play ball instead of working extra hours to fund Sacramento and all of its bloated government and union perks, (since he wont see that majority of the money). How does this situation benefit anyone (outside of the immediate family)?

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