Wednesday, August 9, 2017

Drinking Beer and Tax Reform

President Trump and congress have stated that one of the next major issues on their agenda, which they will begin working on in 2017, will be tax reform. 

Now I don't necessarily believe they will be any more successful with this exceptionally difficult endeavor than they were with repealing and replacing Obamacare.  After all, the GOP senators had already voted to repeal the inaccurately named Affordable Care Act multiple times when it didn't matter and had no chance of actually being repealed when President Obama was in office.  Of course they refused to cast that same vote when President Trump would have signed the bill.  Why would we believe that these integrity-challenged charlatans would be willing to expend political capital to fix our broken tax code next?

Regardless, we can hope that these cowardly and incompetent people that populate our House of Representatives and Senate might overachieve just once in their careers and actually be able to enact meaningful tax reform.

Of course any tax reform that doesn't raise taxes on the "evil rich" will immediately be vehemently decried by some of our fellow Americans as being grossly unfair and exploitive of the poorest amongst us.  It is nonsense, as the poor do not pay federal income taxes currently and surely won't in the future, but mark my words that the cacophony of demonization will happen as surely as President Trump will continue his incessant "tweeting". 

With all of this being said, a friend of mine recently forwarded this simplified explanation of how our progressive tax system functions, and the likely results of that reform being excoriated by the ignorant and ideologically partisan pundits and politicians when and if actual tax reform does come to fruition.  Enjoy!

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 ball.
“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 men would 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?
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 every body's share, then the fifth man and the sixth man would each end up being paid to drink their 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 he proceeded to work out the amounts he suggested that each should now pay.
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 (29% 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 (17% 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. "I only got a dollar out of the $20 saving," 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 received ten times more benefit than me!"
"That's true!" shouted the seventh man.  "Why should he get $10 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. This new tax 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 their beers without him.  But when it came time to pay the bill, they discovered something important…they didn't have enough money among all of them for even half of the bill!
And that, boys and girls, journalists, politicians, and pundits is how our 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.

20 comments:

Majormajor said...

You mean there is no free beer?

T. Paine said...

Nope. No free lunch and no free beer, my friend!

Jerry Critter said...

That's an entertaining story, TP, but its application to any impending tax reform is somewhat remote. The basic element of the story is that the price of the beer has dropped for $100 to $80, providing a $20 surplus. That surplus is eliminated by adjusting the price that the various drinkers pay.

We have no such surplus with our current tax system. There is no surplus to be eliminated through adjusting the tax rates. For your story to have any relevance, we must cut government spending first to create a surplus.

Cutting government spending first sufficiently to create surplus tax revenue won't happen. Instead, we will be told that reducing taxes will increase tax revenue. That's like the beer drinkers telling the bartender that they are only going to pay $80 for their beer and expect to get an increase in the amount of beer that the bartender gives them.

Majormajor said...

Jerry,

"We have no such surplus with our current tax system."

Yet each year tax revenues break records. Is the ACA preventing s surplus?

What system would you suggest that would produce a "surplus"?

T. Paine said...

Jerry, sadly I must admit that you are right. We have not brought in more revenue than we have spent for ages. Doesn't it seem odd that we cannot find any waste, fraud, abuse, or flat out un-constitutional spending that we could cut? I guess every constituency group has their sacred cows, so we won't ever see any meaningful cuts, let alone a balanced budget.

All of that said, if done correctly, there is a balance where tax cuts do indeed increase revenues to the federal treasury, my friend. We saw this in the 1980's. The problem then, as now, is that we continued to spend even more than we brought in.

woodenman1954 said...

T.Paine , I agree with you there is no free lunch or beer but the is tons of free caviar and Dom Perignon for the right people.

They bailed out the banks with 16 Trillion dollars and 90 billion a month for years after that with QE. None of it was ever paid back and was not supposed to be.

The Bush tax cuts gave 2 1/2 Trillion to the elite in 8 years, Obama toned it down and made the rest permanent.

Chaney created a "Tax Holiday" and let corporations bring home 3/4 of a Trillion in off shore profits just about free and clear.

Armament manufacturers routinely get blank checks, Two Trillion for the F22 and the F35, and they are poorly designed. Russia is make superior planes,tanks and missiles for less than a tenth of what we pay.

The fossil fuel companies and the nuclear industry received more than a Trillion dollars in the last three decades and they are some of the richest corporations on Earth.

We have 17 redundant intelligence agencies costing hundreds of billions a year with 1500 subcontractors like the one Snowden worked for making huge salaries. If the Russians did effect our election then all the agencies should be dismantled immediately.

There are hundreds of more examples like these and that is why we increase the national debt by almost one Trillion a year. I have faith that the Republicans with deliver train loads of free caviar to the wealthy for the next four years.





woodenman1954 said...

I should replace the word Congress for Republicans in the last line because Democrats do it also.

Majormajor said...

Here's the question, if our highest in the world 35% corp tax is preventing corporations from bring home their profits to be taxed, what level of taxation would the liberals be happy with that would end that trend?
20%?
25%?
15%?
Right now the tax receipts are zero, would they be happy with anything less than 35%?

T. Paine said...

Woodenman, sadly there is too much truth in what you say. Indeed I think you and I are far closer on this topic than what you might think.

Government should not have bailed out the banks for taking foolish risks because they KNEW they were too big to fail and that the government would come in to save them. Frankly the folks that were responsible should have been made examples of with very long prison sentences. That would have gone a long way to ensuring that this doesn't happen again.

As for the quantitative easings, well that is also the height of asinine foolishness. Indeed all that did was give an artificial stimulus to the stock market at the expense of the federal debt. It is unsustainable.

As for the Bush tax cuts, a lot of that also went to helping out the middle class. I recall receiving some of my tax dollars back, and I am hardly rich. That said, I can understand a case being made against tax cuts when we are so deeply in debt as a nation. Targeted cuts can be beneficial to stimulate the economy and leave some more of the hard-earned income in the hands of the middle class, but it must be done with precision instead of just rewarding favored constituency groups.

Next, I further agree that many within the defense industry do indeed seem to always get huge contracts which they often are late with their deliverables and charge for over-runs in "costs". National defense is one of the few things that the federal government has a constitutional duty to fund and procure equipment for accordingly. How this is currently done definitely smacks of insider deals and corruption. I am absolutely NOT a fan of President Trump's but I was heartened to see him push back on contracts for the new Air Force One planes and some of our other military aircraft. Far more of this should be done routinely and as a matter of course.

As for the designs of our planes and armament, I admittedly am not up to date on this like I used to be. I know during the cold war our equipment was far superior to anything Russia fielded in the air, land, or water. I think renewed and draconian oversight is needed to ensure that every tax dollar spent is worthy of the equipment we receive from defense contractors. Of course, none of this will happen as congress and the MIC are in a seemingly symbiotic relationship.

I also agree that corporate welfare to oil companies, corporate farmers, etc. should be cut completely off... 100%! Yes, this will cause a rise in prices for some goods and services, but the true costs of such will be born by the consumers and not by the tax payers.

Sadly, these problems have been going on for years regardless of whether the Republicans or Democrats were in control of congress. Until we get rid of every last senator and congressman and put civically-minded, constitutionally-literate people into office that want to serve no more than a few terms as a DUTY and not as a means to get rich into office, we will continue to see this problem only worsen.

Unfortunately, most Americans can tell you the name of who won "The Voice" but cannot tell you the name of their own congressman. It is hard to hold anyone accountable when such ignorance and apathy abounds, sir.

T. Paine said...

Majormajor, you also make an excellent point. We need to lower corporate tax rates in order to keep businesses here and bring back some of those that left. Indeed, it is exceptionally hard to compete globally when we routinely have the highest corporate taxes on the planet. That said, corporate welfare and the myriad of tax incentives to the huge corporations in bed with the government must stop now.

Paul said...

Communal taxation has been an accepted method to help build the greatest nation on Earth. It's pretty simple math actually, pay as you spend. We did.
The WW II generation taxed themselves at a very high rate, because of their high expenses. They didn't pass on those bills to their offspring. They did vote for programs that are the biggest part of our growing debt now. They made a commitment and backed it up with their money. Thirty years after the "big deals" of the FDR government, they recommitted to even more government promised benefits under LBJ.
Their offspring (the baby boomers) seem to want those benefits, but refuse to pay for them. From Reagan on we have cut taxes. A very popular platform from politicians running for elected office. "No New Taxes", "Cut Taxes", take the "Tax Cut Pledge." It was a successful strategy. Meanwhile, our debt has continued to climb.
We now pay about half in taxes what our parents generation paid. Lets not forget the greatest growth period in American history was during the period of those highest tax rates in American history. It seems higher taxes does not inhibit growth.
There is evidence that cutting taxes will increase revenues to the Treasury, but they are a small fraction compared to increasing expenses. So it's a losing strategy.
I believe in theory with a "progressive" tax code. The more you make, the more taxes you pay. I believe capitalists have an obligation to the community they do business in. They have an obligation to produce basic needs and supply the population. They have an obligation to produce jobs and living wages for the population. If they can't sustain the population, then capitalism is a failure.
How many companies, after legal tax deductions, are actually paying a 35% tax rate? If people are working, yet, qualify for federal poverty benefits (like Walmart workers and many other workers) why should tax payers subsidize their workers just so those workers can have basic needs like food and shelter? Meanwhile, the numbers tell us companies are cash rich and driving the financial investment business and Wall Street. By the way, the stock market is way overvalued and a serious correction (10% or more) is coming.
This debt has been built in 30 years. One generation. Maybe that generation should pay a heavy death tax to pay for what they refused to pay for over the last 30 years. Certainly future generations should not be strapped with their bills and be unable to finance their spending to build a better, future America.
The rich were not the only ones getting tax cuts and should not be the only ones paying higher taxes. Tough love - We all have to pay more taxes, or cut spending to the point where literally millions will die. And that brings us back to why the WW II generation decided to vote for those programs in the first place. They lived through the unnecessary deaths of people, because they could not get enough money from their jobs to survive and had no safety nets from their government. The Great Depression was the straw that broke the camels back. The cry from the people had been going on since the industrial period of the previous century.
What kind of society do you want to live in and how much are you willing to pay for it?

T. Paine said...

Hi Paul! First, thanks for your thoughtful comment, sir. There is a lot of what you have written that I agree with, and some that I don't.

I understand and support the reasons for communal taxation. It is necessary, but should only be done to the degree necessary to fund those vital functions that the federal government is SPECIFICALLY authorized to do under the United States Constitution. Any extra-constitutional or un-constitutional funding of programs, bureaucracies, and entitlements not specifically enumerated should be stopped, as those rights belong to the states and/or people as stipulated in the 10th amendment.

I also agree that we have been foolish for not paying our tax burden as we go. Unfortunately with the bloated, inefficient and wasteful government we now have, it is nearly impossible to tax our way out of the $20 trillion debt we now have as a nation. The ONLY way we can survive this is if we do return to our small, fiscally prudent, constitutionally-guided government. Of course it will never happen, so we are destined to eventually collapse under this massive debt that we have amassed in order to provide corporate welfare and myriads of entitlement programs.

Cutting taxes at the proper amount along the Laffer curve will indeed generate revenue. Cut too much, and it will only create more national debt. Cut too little and it will also not bring in any additional revenue. The process does work, as the 1980's proved under Reagan. The problem is that for every new dollar of revenue created, congress spent $1.50.
Further, you are right that most large corporations aren't paying 35% in taxes. This is a part of the corporate welfare of which I speak. In my opinion, most all deductions should be removed and a lower marginal rate should be applied for corporations. In this way the true costs of these companies' products or services would be born by the consumers instead of by the tax payers.

Personally, I don't want to live in a country where the "beneficent government" takes care of all of my needs from the womb to the tomb in exchange for 50% of my income. I would move to a Scandinavian country or elsewhere in Europe if that were the case. I simply want the government to do ONLY that which it is constitutionally allowed to do. Our fifty states and local communities that are closest to the needs of the people can and by constitutional right should take care of the few other needs that we cannot do for ourselves. Unfortunately too many people today when faced with a problem look to Uncle Sam for the solution. That is what has fed this monstrosity. It is unsustainable and will eventually collapse. How many tens of millions of people will suffer and/or die when that happens, sir?

Again, thanks for commenting!

Jerry Critter said...

TP,
Interesting that you should mention the Laffer Curve. If you look at actual data rather than "thought" data, it appears that Laffer got it upside down.

T. Paine said...

Jerry, that is an interesting theory, but I hardly think it is accurate. It is merely a counter theory to Laffer's. I think it is a far greater supposition than Art Laffer's initial drawing. I don't think we are going to get 16 to 17% of GDP in governmental receipts when the top marginal tax rate is 0% any more than I think it will be 26 to 27% of GDP when that top rate is at 100%. First of all, when you compare receipts to GDP as a percentage, it doesn't tell if GDP has shrunk or grown under those conditions; it only shows the ratio of receipts to it.

Further, knowing human nature, particularly in today's society, would it make sense that we would have an increase in receipts as the top rate exceeded the 90th percentile? People would be finding tax shelters, moving accounts offshore, or simply no longer working. I sure as hell would not work, even at a million a year, if I were to only bring home $50K while 95% went to Uncle Sam.

Jerry Critter said...

TP,
I think it is a little more than a counter theory to Laffer in that it is based on data while the Laffer curve comes from a napkin. That said, what happens at 0% and 100% top marginal rate is clearly not shown or explained. But then, there is no data at the extremes. Within the the confines of the data, a minimum is clearly shown.

Also, remember, this is the top marginal rate. Someone, even you, making $50,000 per year will not be paying the top marginal tax rate on any portion of your $50,000.

You bring up a very valid point. Using the ratio of tax receipts to GDP complicates the interpretation of the results. But then, are we really trying to maximize tax receipts? I don't think so. The reason generally given is to improve the economy, make it grow faster, something that benefits everyone. So, perhaps we should look at the impact of tax rate on GDP.

That has been done. It shows that the optimium top marginal tax rate is approximate 65% based on real economic data. That means we should be increasing taxes, at least at the top end if we want the economy to grow.

Or, perhaps the real purpose of tax reform is not to improve the economy, not to do something that benefits everyone. Lowering the top marginal tax rate will accomplish one thing. It will give very rich people more money. Granted, it will slow down economic growth for everyone else, but I don't think they care.

Paul said...

Good morning Mr. Paine,

Of course, what is constitutional, is what the Supreme Court says is constitutional.

The enumeration of what the Federal Constitution allows, or not has been changed by the legislative process many times since the signing of the Constitution in the 18th century.

FDR programs like Social Security were brought before the Supreme Court and were found to be constitutional. The Supreme Court at that time found many of FDR's policies to be unconstitutional. That's when FDR tried to pack the Supreme Court with appointees favorable to his ideology by trying to add 3 spots to the Supreme Court panel. Sounds like something Trump would try to do and I am glad FDR was not successful.

Like any other Constitutional provision, the 10th amendment is not untouchable and can be amended. Good, solid legal thinking is behind the idea that it should not matter where a citizen lives to have certain individual rights protected by federal law (like abortion - just an example not an abortion stance) without violating the spirit, or intention of the 10th amendment. Slavery, of course, was the example presented at the Constitutional Convention. I believe individual rights should trump States rights. I also believe when judging law, individual rights should succeed over States rights and the Constitution makes that clear in its preamble.

I'll agree with you about the Laffer curve, but then lets both admit it has failed, for the reasons you mentioned. A financially deadly mistake by Reagan and Republicans to not cut spending at the same time they cut taxes. It is a fine line to determine how far to cut taxes and spending, but obviously doing only one was fatally flawed.

Yet, instead of correcting that mistake, Republican economic policy became just tax cuts for the next 40 years, only compounding the problem. And at almost 20 trillion in debt, that is still their policy today. As I mentioned in my first comment, to me it's simple math, but it seems getting Congress to do the simplest things is the hardest task.

Leadership is about getting the people to do what they should, not giving them what they want.

The people obviously wanted FDR policies to lead their lives, but I for one am glad our laws put a limit on the number of consecutive years a person can be president. Not because I disagree with FDR policies, but because one sided government is not healthy. I believe divided government with healthy debate is best, but it seems healthy debate has disappeared from Congress and the public.

We have to fall back on what the people vote for. The people have voted for the Republican policies of tax cuts, for decades, and the people have voted for Donald Trump. This is what the people want and leadership is giving them what they want, not what they need. FDR will go down in history as America's second most popular president by giving the people what they wanted and historians seem to think that's what America needed at the time.

But cultures and values change from generation to generation. So the good intentions of our parents generation will harm future generations because the current generation refuses to pay for the dreams of their parents decisions. Is that selfishness, or just the reality of two different generations colliding? Probably both.

I don't agree our finances are beyond the point of being fixed. I agree they will not be fixed. I feel lucky to have lived in the time America's finances and growth were at their healthiest, which allowed me to prosper. I feel sad for future Americans who will be strapped with my generations mistakes. I feel my generation has failed to leave the country better off than it was given to us. I see it as a great failure.

T. Paine said...

Jerry, Art Laffer's theory may have been something that he originally "doodled" on a napkin, but the basis upon which he made his drawing was expounded on afterwards to great extent. Indeed, his "Laffer curve" was something based on economic theory that predated his napkin masterpiece.

I understand that the counter-curve you have shown was regarding the top marginal rates, sir. I think you may have misunderstood me, however. I was stating that if I make $1 million dollars and am taxed at a 95% marginal rate so that my net income is $50,000, then I personally would choose to no longer work under such a draconian system that confiscates nearly all of the fruits of my hard labor. I think that human nature suggests that most people would follow my course of action in such circumstances.

"...are we really trying to maximize tax receipts?" ~ Jerry

I was under the impression that this was exactly the argument from the anti-supply-side. The goal was to absolutely improve tax receipts. Ironically you picked up on my argument that we may be increasing tax receipts as a percentage of GDP, but that does us little good if the economy is shrinking and thus hurting most workers. Simply raising taxes does not necessarily improve the economy. Increasing taxes too much causes businesses and the wealthy to look to hide their taxable assets overseas or by shedding them. That does not help the domestic economy accordingly, my friend. It is an economic truism that whatever we tax, we get less of eventually, while whatever we subsidize, we will always get more of in the long run.

The article you cited states that the optimum top marginal tax rate should be 65% plus or minus 10%. It is an interesting assumption. I am not certain that I buy it though. Again, citing human nature, if you take 2/3rds of everything made for those falling into the top marginal tax rate, I think they are going to start looking to shelter that income so that their overall tax burden is far less.

I think that congress and Trump should not focus on cutting taxes so much as simplifying the tax code. I think if we remove most all of the deductions available, particularly for the top tax rate and streamline the process then we will see tax receipts increase, as well as an expansion of GDP. I would love to see a Steve Forbes simplification of your taxes being able to be done on a post card, but I am not so naive as to think this group will actually get anywhere near that with their tax reform.

For the record, simply cutting taxes will not fix the problem, in my opinion.

Jerry Critter said...

I don't want to beat a dead horse, but I have just a couple of points of clarification.

I am sure you realize that the to marginal tax rate does not apply to all of your income. Your example of an unrealistic high marginal tax rate of 95% would only be applied to your income of above some base amount, not to the total 1 million. Income below that base would be taxed at Some lower rate. Again, as you know, everyone is taxed at the same rate on the same amount of income. For example, your first $50,000 is taxed at the same rate as everyone else's first $50,000.

Secondly, the 65% +/- 10% is not an assumption. It is a fact based on the economic data used in the analysis. You might refute the data and/or the analysis, but calling it an assumption is not correct. It is merely an attempt to diminish its relevance.

And finally, the argument for a tax cut coming from the republicans is to improve the economy. They say we don't have to worry worry about the tax cut increasing the debt because the increase in the economy will also overcome the lower tax rates and increase tax revenues. This is contrary to what the economic data shows.

T. Paine said...

Hello Paul. While you are correct that whatever SCOTUS says is constitutional is indeed the technical definition of constitutionality, you must admit that the Supreme Court has made some horrific decisions in its past that absolutely are clearly opposed with the spirit of our constitution and Declaration of Independence. I give you Dred Scott v. Sandford, Plessy v. Ferguson, Roe v. Wade, and the infamous Obamacare decision in 2012 as examples just off the top of my head.

And of course, the amendment process is exactly what the founders intended for us to use if we chose to change any duties or restrictions enumerated in the Constitution. That said, we have made many many spending increases, creation of government agencies, and governmental usurpation of rights and duties that are not in the Constitution and have not made any such amendments allowing these changes, sir.

I think state's rights supersede federal rights, EXCEPT those specifically listed in the Constitution, as stated. I would agree with you that I think most individual rights should be preeminent over all other rights as long as they don't "pick my pocket nor break my leg".

"A financially deadly mistake by Reagan and Republicans to not cut spending at the same time they cut taxes. It is a fine line to determine how far to cut taxes and spending, but obviously doing only one was fatally flawed." ~ Paul

I would absolutely agree with you on this excellent point, Paul. Indeed Reagan did want some spending cuts and was promised them; however, Tip O'Neil and congress ended up spending the additional tax revenue received. (Albeit, the build up of our depleted military and the SDI initiative spending was exorbitant and basically caused the USSR to collapse trying to keep up with the U.S.) One can debate if those defense expenditures were thus justified. I personally think they were. Simply cutting taxes, however, without looking at spending cuts is indeed foolish and a recipe for a dangerously greater national debt, as you so stated.

"I believe divided government with healthy debate is best, but it seems healthy debate has disappeared from Congress and the public." ~ Paul
Amen! Sadly this doesn't look like a trend that will change any time soon.

As for some generations being irresponsible in their spending, thus harming our future generations, I would obviously concur. I don't know what generation of which you are a member, but it seems that we have been spending far more than what we earn as a nation for many generations now. To fix our current fiscal situation, we would have to change the entire mindset of a nation. We would have to teach individual responsibility again instead of looking to government as the end all and be all of our salvation. We need to ask what we can do for our country instead of expecting it to do everything for us. Until such a time comes when we can be reasonable grownups and return to a limited constitutionally-bound federal government, we will never even balance our budget as a nation, let alone pay down our national debt, my friend.

T. Paine said...

Jerry, I appreciate your points of clarification, sir.

First, while I do know and realize that the marginal tax rate does not apply to all of my income (thus it is "marginal" in its taxation) I did indeed fail to take that into account for my hypothetical example. Thanks for keeping me honest. :)

Second, I do dispute that data's analysis for a 65% tax rate. I liken it to President Obama's touting of the CBO's excellent analysis that stated that the ACA would not add debt to our national treasury when that clearly has not been true.

Last, to a certain extent I agree with your point, Jerry. Simply cutting taxes as a means to improve the economy may or may not have that desired effect depending on many different factors and variables. Any tax cuts should absolutely be done in conjunction with very large spending cuts, as Paul stated, accordingly. Only then would we be more ensured of seeing an economic boom and the reduction of our federal debt.