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How the Tax System Works

 
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John_B
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Joined: 03 Jul 2004
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Location: Milwaukee, WI USA

PostPosted: Fri Jul 01, 2005 8:31 am    Post subject: How the Tax System Works Reply with quote

I did not write this, although I wish I did. The author is T. Davies, professor of accounting at the University of South Dakota School of Business. It has been reprinted in several magazines which is where I found it. Here it is word-for-word. Enjoy!

Let’s put [income] tax cuts in terms everyone can understand. Suppose that every day, 10 men go out for dinner. The bill for all 10 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 10th man — the richest — would pay $59. That’s what they
decided to do.

The 10 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’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. So the first four men were unaffected. They would still eat for free.

But what about the other six men, the paying customers? How could they divvy up the $20 windfall so that everyone would get his own “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 now paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the 10th 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 10 customers began to compare their savings.

“I only got a dollar out of the $20,” declared the sixth man, pointing to the 10th. “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 10th and beat him up. The next night he didn’t show up for dinner (or, in the real world, he took his business out of the country), 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 $52 short of paying their 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!

Irv’s comments: The sad part is we have not figured out how to beat the income tax. Earn and you pay. Earn more and you pay more. Sad!
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PostPosted: Sat Jul 02, 2005 6:38 am    Post subject: Why they don't work Reply with quote

On the surface, right on the money, and a very good example, but that's not the way tax cuts really work. The example totally ignores reality and our system of social services. Social services are crucial for poor people, it's the only thing keeping them alive. The four poorest people in the example are basically unaffected. They don't have much to begin with have even less afterward, but the social services safety net manages to keep them alive. Their lives don't revolve around money, they revolve around services provided to them by others. The first four men were correct. The system exploits the poor, as they suffered the most from the tax cut. Not only didn't they get any money from the tax cut, they lost what little they had! They didn't lose any money, but they lost food, shelter, healthcare, and other essentials. Those hovering around the poverty line, let's say #5&6, who make too much money to utilize most social services, but who have menial, low income jobs, still have to pay fairly high insurance premiums or college expenses because they make too much to qualify for tuition assistance, were also big losers in this example.

Going from paying $1 to $0, or from $2 to $1, really does nothing to improve their situations because now they might make enough money to lose the advantage of one of the social programs they previously qualified for - which, from #10's perspective, was the whole purpose of the tax cut - to reduce the amount spent on welfare programs, and put more money in his and #9's pocket - the two of them received almost 70% of the tax cut in the form of cash back in their pockets. That's really what the $20 reduction was - a reduction in social service programs. As a result of the tax cut, the poorest people lost $13 of the $20 they used to receive in welfare programs. Let's assume that prior to the tax cut #5 was able to receive $2 worth of food stamps per day. After the tax cut he has a $1 more in his pocket because of the tax break, but he's lost $2 of food stamps, because his increased earnings have made him ineligible for food stamps, actually making him worse off than he was before. #10's happy because he's taken that $1 from #5 and put it back in his pocket. #9's happy because he's taken $.50 from #5 and put it back in his pocket. In this example, #9 actually benefits much more than #10 as his taxes have been reduced by a whopping 50%, which is exactly what #10 needs. #10 needs strong support from #9 and needs #9 to believe he has significant wealth so that #9 will continue to support #10. In reality, #10's wealth dwarfs #9's, but he wants #9 to see that he's given him the lion's share of the tax cut on a percentage basis, not himself. #10, who represents the ultra wealthy top 1% of the population, is smart enough to know that he has no chance of staying in power without the support of #9, who represents the 4-5% of Americans who are in control of the economic engine of this country. Now #5 has incentive to beat up #9 and #10 because he understands what's happened to his situation. #10 used to give him $2 of food stamps per day and he's replaced it with $1 in cash instead. He knows that #10 is in a position of power and authority and responsible for the tax cut which supposedly benefitted him but had the exact opposite affect. Without the support of #9, #10 can't survive unless the U.S. becomes the U.K. #9 would never join with the others in beating up #10 unless his life was in danger. Nobody can understand why #5 and #6 are angry and upset, except all their peers who were affected in the same way. Nobody in gov't wants to consider what actually happened to their financial situation because social services, on a individual case by case basis, were not part of the equation. All the public sees is that on page 846 of the Office of Management and Budget's annual report, spending on welfare programs was reduced by 20% as a result of this tax cut. This is what almost always happens to the lower classes when a tax break is passed. Taxes are all about redistribution of wealth and the wealthy always benefit at the expense of the poor when there is a tax cut. The only people who are better off after a tax cut are those who don't utilize any social programs - #7-#10. That's why the republicans always support them and the democrats always oppose them.

If you look at the $20 of taxes as being a donation by the wealthiest to pay for social services, the elimination of the $20 put $18 back in the pockets of #7-10, those who least need it. After the tax cut, #1-6 have lost $20 in services and had them replaced by $2 in cash that went equally to #5 and #6. Groups #7-10 saw their real wealth increase by $18, while Groups #1-6 saw their real wealth decrease by $18. A gross injustice to say the least. #1-4, the heaviest users of social services, lost a great deal of what little they had, but nobody cares about them. They have no political power, no unified voice and are only concerned about survival from one day to the next. Instead of one hot meal a day, they might get one hot meal a week. Instead of staying at the shelter when it's below freezing, they might only get to stay at the shelter when it's below 10 degrees. #5-6 are working class people, primarily minorities, with little political power and are fragmented, but occasionally are able to rally around a charismatic leader such as MLK Jr. and force social change. They use some social services, were net losers as a result of the tax cut, and are the most likely groups to verbally express their outrage and become violent. They lose incentive to work and become disenfranchised because the harder they work the less real wealth they have.

The wealthy are basically unaffected by tax increases or decreases. If their taxes go up, instead of a 14 day cruise they can only justify a 10 day cruise. If they go down, they buy a more expensive car, but the basic quality of their life remains the same. The same is not true for the poor. If you really wanted to improve the lot of the less fortunate without impacting the wealthy, the $20 would be split equally, or more appropriately the wealthiest would receive no tax cut and the poorest would receive all the tax cut, which is essentially what the earned income credit does. After they beat up #10, did they rob him as well and set themselves up as owners of his business? I guess if they did, that would be "nationalization"! Believe me, I'm as capitalistic as the next guy, but our system has to change to provide low income, poorly educated people with the incentive to work, rather than provide them with an incentive to stay on welfare or related social service programs, and still provide the wealthy with the incentive to innovate and increase their wealth. Tax cuts do just the opposite. They provide poor people with incentive not to work because if they earn more money, they actually lose real wealth.

In the extreme, if Bill Gates only keeps $1 of the next $1 million sold by Microsoft, and the balance is divided between 1000 poor people, he's still marginally better off than he would be if Microsoft sales stayed the same, but the other 1000 people are signficantly better off. Maybe they've lost $500 worth of social services, but they've gained $1000 in cash. However, if Bill Gates keeps $900,000 of the next $1 million, he's still only marginally better off - it has absolutely no impact on him whether he gets $1 or $900,000. However, the 1000 poor people are now, although on the surface, also marginally better off with the $100 they each receive, but more likely they've lost $200 of social services, making them worse off overall. The redistribution of wealth didn't do anybody any good, it hurt the poor, causing social unrest and rebellion, and that's the problem with our wealth redistribution (tax) system. Tax cuts always benefit those who don't need it and hurt those who do need it.

Now you know why this accounting professor is teaching at the University of South Dakota instead of the University of Michigan.
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John_B
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Joined: 03 Jul 2004
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Location: Milwaukee, WI USA

PostPosted: Sat Jul 02, 2005 7:18 am    Post subject: Those that work will. Reply with quote

Those that will work will. Those that won't work will not. It is human nature to do what is easiest.

The democrates have created a hammock out of the safety net of social programs. Once a human gets into that hammock they don't want to get out. It is not that they can't it is that they won't.

To use your example of Bill Gates. The richest man in the world does not need to work. However, he does continue to work and allows others to work. What did he do with his tax cut? Did he spend it on vacations? No, because your logic is flawed. If he wanted to use his tax cut on vacations then he would have already been using his profits on vacations. But that is not what the rich do, they use it to make more money, and how do they make more money? They produce, or better stated they higher more employees to produce more. (They higher more humans that are willing to work and not just lay in that hammock!)

You logic mandates that all the money of others should go to the poor so that they end up having the same amount as every other human. When you redistribute wealth that is the ultimate finality that everyone has the same amount which also means there will be no more to redistribute in the end. At that point when all humans have the same amount they will all be in that hammock and no one will want to get out.

But some will want to get out of that hammock. They will want more (either in monetary terms or in the freedom to choose what to convert that money into) so they will do what is needed to allow them to do that.

When humans in one area are not willing to work the entrepreneur will go to where the humans are willing to work. If one geographical location hinders the amount of profit then the entrepreneur will seek out a better location. When some humans demand too much for their services, and other humans are willing to do the work for less, then those who are willing in more ways will get the work. When cities and states hinder production then they will push out the entrepreneur who will find a more suitable location. Some Mexican humans are more willing to get out of that hammock then those in the inner cities of America, because the democrats have given them so much that they have not earned, that when a job comes around that replaces that amount they say no, why should I work for what I get for free? That is human nature.

Economic evolution. Mother Nature seems cruel to some but in the end it is better for the progression of the species. A society of humans that are willing to work even when handed the same that they are working for, is better off.
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