Friday, 23 May 2008

Economy of beer.

I've got a friend who's an investment banker. This means he's pretty knowledgeable on economic issues. He's also politically conservative, so we argue quite a lot. When we talk about economics, I have to refuse to argue points, because if I try, I'll lose. Not necessarily because I'm holding the wrong position (though clearly sometimes I am), but because he can make complex economic statements (about 'growth' and 'interest' and 'recession' and other important sounding words) that he doesn't have to defend, because I don't have the knowledge to attack them. This is pretty annoying.

The point of this post, though, isn't to point out how annoyed I am that I can't argue economic points with him, but to paste an email he sent me today:

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 got"

"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, ladies and gentlemen, 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 anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

As someone who can't argue about economics, naturally, I can't address this with any hope of being right, but if I were to try to, I'd probably say that
  • buying beer in a bar is not analogous to tax, which funds vital public services without which society couldn't function.
  • an arbitrary drop in the cost of beer is not analogous to a tax decrease, which would require a decrease in service quality or a massive increase in service efficiency.
  • the reaction of the less well off to the better off is unrealistic - complain, yes, 'beat up', no. And if the beating up of the rich person was a clever analogy for something else, then it passed me by. Yes, people are envious of those richer than themselves. D'you know what the compensation for being envied is? Having a lot of money.
  • it's interesting that the rich man at the end of the analogy decides to stop helping those that don't appreciate him and move his money to places with 'friendlier' atmosphere towards him and his money. Without him, they can't buy beer (for which read access schools, hospitals or recieve welfare). But what do they matter to the rich man - he's found somewhere that 'appreciates' his money more, and that's what's important.
Clearly there is an important point here - we are dependent to a large extent on the money brought in from taxing high earners, and there is a careful balancing act involved in taking as much as possible from them without taking so much that they leave for a country with more favourable rates.

I don't know what the answer is (see first paragraph), but I don't think this kind of over-simplified analogy helps us get any closer to one.

1 comment:

Andy J. Wotherspoon said...

Well being most definitely left-wing and verging on communist, my general reaction is screw the rich, they can afford to pay more and those who can't afford it shouldn't be punished for not having the good fortune (if you want to call it that) to become rich.

The reaction is probably a slightly over exaggerated one, but I guess relating to the idea of taxing richer people more heavily thus making them want to hold onto their precious pennies and thus move either themselves or their money to a more "friendly environment".

If you give a poor person a million pounds, they will probably spend it frivolously, but when they stop spending it they will probably still have a relatively large sum of money left, it wont last forever but it will last. You give an already rich person the same amount and it will probably either get spent very quickly or hardly make a noticeable increase in their bank balance that it may well have just gone to a poor person.

This is looking at extremes I guess, but then we are dealing with extremes. I'm pretty sure that the amount some of the people being paid in Salford is far less than what the majority of people in London are being paid. (unformed thought)

I guess it's true that the majority of people are reliant on the rich to fund public services, but should we be thanking them? I don't think so, because they are doing it out of requirement, if taxes weren't there they wouldn't pay and those needing the services would probably survive anyway, to say we are totally dependant on the rich seems a bit bullshey. Also if the margins between the poor and rich where lower (closer to the lower end) then surely things would be cheaper in general, therefore the rich are hardly do them any favours. But this is a little pulled out of hat.

Anyway I'm willing to be proved wrong :D