Dinner for 10: A Taxing Analogy

12/27/2002 12:00 am EST

Focus:

Steven Halpern

Editor, thestockadvisors.com

"A tax loophole is something that benefits the other guy; if it benefits you, it is tax reform,'' said Louisiana Senator Russell B. Long. There are few topics as complex, frustrating, and as misunderstood as taxes. T. Davies, professor of accounting at the University of South Dakota, explains the impact of tax reduction through a remarkably understandable analogy that is both entertaining and informative.

"This is a very simple way to understand the tax laws," says Professor Davies. "Read on, as it does make you think!"  Here's his analogy:

"Let's put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for dinner. 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 $7, the eighth $12, the ninth $18, and the tenth man--the richest--would pay $59.

"That's what they decided to do. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement--until one day, the owner threw them a curve (in tax language a tax cut).

"'Since you are all such good customers,' he said, 'I am going to reduce the cost of your daily meal by $20. So now dinner for the ten only cost $80.00.

"The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still eat for free. But what about the other six--the paying customers? How could they divvy up the $20 windfall so that everyone would get his 'fair share?'

"The six men 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 end up being PAID to eat their meal. So the restaurant 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 paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59. Each of the six was better off than before. And the first four continued to eat 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, but he, pointing to the tenth. 'But he got $7!'. 'Yeah, that's right,' exclaimed the fifth man, 'I only saved a dollar too; it's unfair that he got seven times more than me!'

'"That's true,' shouted the seventh man, 'why should he get $7 back when I got only $2? 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 he didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered, a little late what was very important. They were FIFTY-TWO DOLLARS short of paying the bill!

"Imagine that!  And that, boys and girls, journalists, and college instructors, is how the 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 at the table anymore.

"Where would that leave the rest? Unfortunately, most taxing authorities anywhere cannot seem to grasp this rather straightforward logic!"

T. Davies
Professor of Accounting & Chair,
Division of Accounting and Business Law
The University of South Dakota
School of Business

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