A Lesson in Revenue

Happy men eating at restaurant

Now that we’re in the season of the government proposing its budget for the year, I suggest it’s a good time for a simple lesson on revenue. I know, exciting! It seems that so many feel that the “rich” should pay their fair share, without ever defining what that fair share is. Is it 30%? 50%? 80%?

For perspective, consider the following story, author unknown (though it has been erroneously attributed to several people). The story shows in a simplified way how our graduated tax system works:

Ten men go out for lunch. 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 ate every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. He said, “Since you are all such good customers, I’m going to reduce the cost of your daily meal by $20. Lunch for the ten now costs 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 eat 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 eat his lunch. 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 pays $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 eat 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 $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 lunch, so the nine sat down and ate 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 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 eating overseas where the atmosphere is somewhat friendlier.

Now to add some real-life data to this example. According to the Tax Foundation, in 2021 the average income tax rate was 14.9%. The top 1% of earners paid a 25.9% average rate, nearly eight times higher than the 3.3% average rate paid by the bottom half of taxpayers.

Another truth is that the top 50% of all taxpayers paid 97.7% of all federal individual income taxes. The share of income taxes paid by the top 1% increased in 2021 from 33.2% to 45.8%. Over the same period, the share of income taxes paid by the bottom 50% of taxpayers dropped from 4.9% to just over 2.3%. So, the tax burden is being shifted more and more to the “wealthy”, and more and more are eating a free lunch, with some complaining about the breaks that the “rich” get.

This shows that this issue is complicated and that we must carefully consider where our nation’s revenue comes from. Driving the wealthiest among us away will only hurt the situation. In reality, our country doesn’t have a revenue problem, we have a spending problem, but that’s a whole other discussion!

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.

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