Monday, October 29, 2012

The Barstool Economics Fallacy

With the election coming up, Facebook is littered with politically slanted postings. I've put a ton of my friends from both sides of the aisle on silent simply because I don't go to Facebook to read about someone's political leanings. There's one post that pops up a lot that I feel the need to address, though. It's often referred to as "Barstool Economics".

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 paid $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 anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

The most egregious error with the analogy is that it shows a deep misunderstanding of how our tax system works. The nation doesn't get a bill at the end of the year that we then divide up based upon some arbitrary setting. We have a known percentage per tax bracket that we owe, regardless of what the nation spends. There are also other methods of taxation in play that this analogy doesn't consider, such as sales tax, social security, medicare, property tax, capital gains tax, etc. The closest thing that this barstool economics analogy fits is a graduated flat tax system, which is completely different from progressive taxation.

We also need to consider that the payment ratios in this bar stool economics post are quite inaccurate.  The very wealthy pay, at most a 39% tax, so 59/100 of the bill is very far off. And 39/100 is the maximum, although, in practice, no wealthy person pays the maximum percentage. Things like capitol gains taxes, offshore banking and corporate detectible losses allow for an effective tax rate of around 18% while many lower-middle-class people end up with a 30% effective rate.  

Of course, all of this also assumes that the ten people cited in the barstool economics post would actually go to the same bar, would drink the same type of beer, and would drink the same amount of it. That's essentially saying that everyone involved has the same opportunities, the same economic advantages and all equally benefit from the system. And we all know, that's simply not the case.  

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