Should we target taxes on the wealthy?

This is a story from David R. Kamerschen, Professor of Economics, University of NSW that I thought may have some application given the recent changes to superannuation.

Suppose that every night, 10 men go out for dinner at La Porchetta’s. The bill for all 10 comes to $100.They decided to pay their bill the way we pay our taxes and it went like this:

The first four men (the poorest) paid nothing; the fifth paid $1; the sixth $3; the seventh $7; the eighth $12; the ninth $18, the tenth man (the richest) paid $59.

All 10 were 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 meal by $20.” So now dinner for the 10 only cost $80.

The group still wanted to pay their bill the way we pay our taxes. The first four men were unaffected. They would still eat for free. But how should the other six, the paying customers, divvy up the $20 windfall so that everyone would get his “fair share”? ¬†They realised that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth and sixth men would each end up being paid to eat. The restaurateur suggested reducing each man’s bill by roughly the same percentage, thus:

The fifth man paid nothing (like the first four) instead of $1 (100%saving); the sixth paid $2 instead of $3 (33% saving); the seventh paid $5 instead of $7 (28% saving); the eighth paid $9 instead of $12 (25% saving); the ninth paid $14 instead of $18 (22% saving); the tenth paid $49 instead of $59 (16% saving).

Each of the six was better off, and the first four continued to eat for free, as now did the fifth – but outside the restaurant, 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!”. “That’s right,” exclaimed the fifth man. “I only saved a dollar too. It’s unfair that he got ten times more 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. 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 dinner. The nine sat down and ate without him, but when they came to pay the bill, they discovered that they didn’t have enough money between all of them to meet even half of the bill!

That 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 at the table anymore. There are lots of good restaurants in Monaco and the Caribbean.

Written 7 February, 2013

Peter Debus, director of principlefocus NSW, a Chartered Accountant and Chartered Tax Adviser