Ever since the new tax plan was announced by John Key yesterday there has been a proliferation of the  the whole the rich are getting the tax cuts message. Even my own post got lots of rather negative comments about this.

It just shows how little journalists understand how tax works (or maybe they do but just want misleading headlines like this one).

Anyway.. I am continually reminded of this parable, which explains it oh so well, and it goes like this:

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. “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 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 – the paying customers? 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 the fifth man and the sixth man 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 roughly the same amount, and he proceeded to work out the amounts each should pay. And so:

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

Each of the six was better off than before. And the first four continued to drink 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. 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 got ten times more than I!”

“That’s true!” shouted the seventh man. “Why should he get $10 back when I got only two? 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 drinks, so the nine sat down and had 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 that, boys and girls, journalists and college professors, 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 any more. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

So yes it’s true that tax cuts sometimes (indeed even often) benefit the wealthy more in the absolute scene (the example above being $10 out of $59, or $4 out of $18), but in relative terms the higher income earners still pay proportionally more tax.  In fact one of the issues with the NZ tax system is that a very small percentage pay most of the tax.  It was reported this morning on National radio on that 10% of kiwis pay 65% of the (income) tax! That’s not sustainable, and means if we lose even a small proportion of that 10% we could be in trouble (just like a business shouldn’t rely on too many “big customers” – spread the risk).

People often quote how “the very rich don’t pay tax”. I’m prepared to accept in extreme cases this may be true, because some people are able to construct their tax affairs so they pay hardly any tax.  But one off examples don’t take away from the fact that a very small percentage of the population (those earning more money) pay the vast majority of tax in NZ.  And anecdotal stories don’t change the FACTS: Higher income earners pay disproportionately significantly more tax.  Even the NZ treasury says (in 2009):

The scope for getting lots of distributional impact through the tax system is much more limited than people think, with the top 1% of taxpayers already paying 15% of income tax.

And John Key has made it clear – unless low income earners own rental property (which hardly makes them low income!), they will be BETTER off under the new tax changes.  Since I haven’t seen the details yet I am unable to comment further, but then again neither has anyone else who’s winging about “it will hurt the poor”.  Let’s wait and see shall we?  Quoted from the NZ Herald

He (John Key) acknowledged that higher income families would benefit more from the tax cuts, because they pay more in tax. Lower income earners would be no worse off – unless they owned rental property – and he expected them to be better off.

He said the Government would not increase GST “unless it saw the vast bulk of New Zealanders better off”. “GST is a very difficult tax to avoid, no matter how people structure their financial affairs. As David Lange once observed, even drug dealers pay GST.”

Aiming for greater equality about by dragging the top down never works (IMO), the focus should be on having an environment where success is celebrated, and the opportunities for everyone to succeed are there (and then a safety net for those those that don’t make it).  Having an effective top tax rate of over 50% (39% income tax + 12.5% GST) is no different from reducing someone’s benefit $50 when they earn $100 from a part time job – both are wrong because they don’t encourage earning /producing more, they encourage earning/producing) less.

Black and White Version: When someone gives lots of something, and then gets some of it back its not unfair.  Remember it was theirs to start with.

Hat tip: Found a copy of the parable here, and they mention the disputed origins of the text.

Post to Twitter Post to Delicious Post to Facebook Post to StumbleUpon