I had got this as an email somedays back. With the latest Budget plans of the Indian Government, I thought this would be the right time to share this with all. It made a lot of sense to me. I have customized it a little bit to fit to India scenario (I hope the original author doesn’t get offended by this). Check it out.
“Understanding Tax Cuts” By: David R. Kamerschen, Ph.D
Sometimes politicians, journalists and the critics exclaim; “It’s just a tax cut for the rich!” and it is just accepted to be fact. But what does that really mean?
Just in case you are not completely clear on this issue, I hope the following will help. Please read it carefully. Let’s put tax cuts in terms everyone can understand.
Suppose that every day, ten men go out for dinner and the bill for all ten comes to Rs.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 Rs.1.
- The sixth would pay Rs.3.
- The seventh would pay Rs.7.
- The eighth would pay Rs.12.
- The ninth would pay Rs.18.
- The tenth man (the richest) would pay Rs.59.
So, that’s what they decided to do. The ten men ate dinner in the restaurant 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 meal by Rs.20.” Dinner for the ten now cost just Rs.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 Rs.20 windfall so that everyone would get his ‘fair share?’
They realized that Rs.20 divided by six is Rs.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 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.
- The fifth man, like the first four, now paid nothing (100% savings).
- The sixth now paid Rs.2 instead of Rs.3 (33% savings).
- The seventh now paid Rs.5 instead of Rs.7 (28% savings).
- The eighth now paid Rs.9 instead of Rs.12 (25% savings).
- The ninth now paid Rs.14 instead of Rs.18 (22% savings).
- The tenth now paid Rs.49 instead of Rs.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 rupee out of the Rs.20,” declared the sixth man. He pointed to the tenth man,” but he got Rs.10!”
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a rupee, too. It’s unfair that he got ten times more than me!”
“That’s true!!” shouted the seventh man. “Why should he get Rs.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 dinner, 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.
[ David R. Kamerschen, Ph.D, Professor of Economics, University of Georgia ]