A little pub fable illustrates the danger of over-taxing the wealthy, says Freddy Barker
The Guardian shoved tax to the top of the agenda on Monday by revealing that HMRC has secretly settled multi-billion pound corporation tax disputes worth £4.5 billion.
Read more about the ‘sweetheart tax deal’ here
As Ed Miliband will soon be squeezing himself on to the bandwagon — arguing that far from being ‘in it together’ the government is cosying up to big business and wealthy individuals — I thought I’d share a fun explanation of the dangers of overtaxing.
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Found here, the novelty of the explanation derives from the fact that the author has used beer to prove his point. To paraphrase his economic fable:
Suppose that every day, ten men go out for beer and the bill for all ten comes to $100, the tale begins. If they paid their bill the way that US citizens pay their 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.
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The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner said ‘Since you are all such good customers, I’m going to reduce the cost of your daily beer by $20.’
The group still wanted to pay their bill the way the US pay their 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 six of the men 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 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, each pointing to the fact that the tenth had more off in absolute terms than anyone else.
Soon, the nine men surrounded the tenth and beat him up.
Unsurprisingly, 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 so the author concludes that this is how the 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.’
Read more from Wealth Wednesday
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