Let's put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for dinner. 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 $7, the eighth $12, the ninth $18, and the tenth man -- the richest - would pay $59.

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 (in tax language, a tax cut).

"Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20." So now dinner for the ten only cost $80.00."

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 -- the paying customers? How could they divvy up the $20 windfall so that everyone would get his "fair share?" 

The six men 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 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.

And so the fifth man paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59. 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 who pointed to the tenth. "But he got $7!"

"Yeah, that's right," exclaimed the fifth man, "I only saved a dollar, too! It's unfair that he got seven times more than me!"

"That's true!" shouted the seventh man," Why should he get $7 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 he 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, a little late, what was very important. They were FIFTY-TWO DOLLARS short of paying the bill!

Imagine that!

And that, boys and girls, journalists and college instructors, is how the 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 at the table anymore.

Where would that leave the rest? Unfortunately, most taxing authorities anywhere cannot seem to grasp this rather straightforward logic!

© The Unknown Taxpayer

 Web Note  The above story was sent to us from a Financial Sense long-time visitor. He had received it from someone else. I imagine this story has made the Internet rounds many times! I did track down the source of his email to Professor Thomas L. Davies, Professor of Accounting & Chair of the Division of Accounting and Business Law at the University of South Dakota, School of Business. I searched their site, found his email and wrote for permission to publish the piece on our site. Below is his response:

"Thank you for your message. I previously distributed the "How Taxes Really Work" article (as well as other opinion pieces reflecting different perspectives) to my graduate tax class to encourage them to think beyond the rules and regulations. Unfortunately, it is rather easy to focus on the myriad of complex rules and forget that tax policy frequently influences taxpayer behavior beyond what may have been intended. Thus my students are frequently asked to think "outside the box" and consider such topics as tax complexity, alternative forms of taxation, and the impact of taxes on behavior.

The article was not written by me, and I have intentionally avoided commenting on its validity in order to encourage my students to think critically, and to assist in the development of their analytical and communication skills. I am unaware of the true author's identity, which is unfortunate, since the piece has generated considerable interest. Unfortunately, one of my students sent it along and erroneously attributed the authorship to me. Obviously I am unable to give permission to reproduce it, and I request that you don't attribute it to me if you happen to send it on."

Jim and I think this story/allegory/whatever is one worth reading and sharing with our visitors. If anyone knows who the "true" author is, we would very much appreciate their permission. We respect copyright laws and do not want to infringe on their rights... taxpayer or not.

Do you have an opinion? Contact Us

FSO Visitor Comments on "How Taxes Really Work"

02/03 Dave, Ocean Port, NJ
Excellent story/parable. This little ditty should be required reading in every school and government office. When trying to explain "tax fairness," I give an example of "two people walk in a store, each buys a $2.00 item. The first person pays with a $5.00 bill, the second pays with a $10.00 bill. As the clerk starts to give back their change, the first customer complains of the unfairness of it all. "Why should I get back only $2.00; while they get back $8.00?", the customer fumed, "it's just not fair". "Just because they had more money to give to the clerk, that is no reason for them to get back more!"

02/01  Dan, Georgia, USA
I enjoy your website very much and have learned so much. Thank you very much. I also enjoyed your article on "How Taxes really Work." I want to share with you something you may or may not be aware of regarding income taxes. I know you are a CPA [Jim is a CFP - Certified Financial Planner, not a Certified Public Accountant] and I hope this doesn't offend you. I used to work in public accounting myself. Anyway, here goes: There is NO law requiring 99% of Americans to even pay an income tax or file an income tax return. Am I saying you should not pay taxes? Of course not. All I'm saying is that, under the Internal Revenue Code and Title 26 Code of Federal Regulations, you'll find it impossible to find a law making most Americans liable for income taxes if they earn domestic source income only and live in the US.

01/30  H. C. Visalia, CA, USA
Critics of Bush's tax reduction plan, who point out that the poor pay a disproportionate share of payroll taxes, forget that these payroll taxes go to the social security program. These are not income taxes and to bring them into the argument is simply fallacious. If these critics want to do something for the non-taxpaying group in our population, they should enact some kind of welfare legislation and be honest in describing it for what it is.

01/30  V. V., Mississauga, Ont., Canada
Thank your for a great article that explains how the income tax system really works. Those who claim that the article misrepresents the true taxation picture by ignoring social security taxes are only partially correct. While it is true that the poor tend to pay a higher proportion of their income on SS taxes, that fact is not relevant since the taxes are supposed to fund a form of public pension that is paid out in monthly installments upon retirement. Since the total SS benefits are capped, it is only fair that the taxes are also capped. The sad fact is that government activities cannot make us richer, they only serve to make the general population poorer. The best thing for all of us if government reverted to the limited form that the American Founding Fathers envisioned. Unfortunately, that is unlikely to happen.

01/30 P. DW, Holland, Netherlands
Divine Law issued by God to the just formed Israelite nation at Mount Sinai states amongst other, that no more than 20% tax burden is to be levied in total, of which 10% serves to finance the daily religious duties, whereas the other 10% is intended to service all other activities at the village/city/national levels including maintaining the armed forces.

The Israelites as a nation were expelled some 400 years later from their Promised Land Canaan after they had entered it, because they had consistently failed to keep the 10 articles of the Divine Law properly. Since then there is not one nation on Earth left that maintains other than draconic tax laws, because all men are wiser than God, they think.

01/30 C. L., Wichita, KS, USA
You need to update the "How Taxes Really Work" to account for the "Earned Income Tax Credit". Under the EITC, some of the "taxpayers" would be paid to eat.

01/30  B. M., East Palo Alto, CA, USA
I just read the story about the 10th taxpayer. Given that some people instantly scream "unfair" when tax cuts save more money for the higher income people, this article does a service in clarifying that it's not necessarily unfair. But it's not a lone voice in the wilderness, in that I've heard this point made many times in other media sources, so the value of making this point (yet again) is not earth-shattering.