Anyone who has surfed the Web and has an interest in politics
or tax policy has surely come across an essay entitled "How Taxes
Work." The essay, which was
collected by Snopes.com via e-mail in 2002, is a parable which purports to offer
a "VERY simple way to understand the tax laws." A copy of the essay, and a discussion of its
provenance, may be viewed here.
The parable is easily recognizable as right-wing propaganda,
designed to demonstrate that the U.S. tax system transfers wealth from the rich
to the poor, and that if the poor want to continue to benefit from the
generosity of the rich, well, they had better start being a little more
appreciative.
The parable is a transparently poor model of the U.S. tax
system, but I found it devilishly difficult to explain why. Furthermore, I was unable to find a
satisfactory rebuttal to the essay online.
I have therefore taken it upon myself to offer my own critique of the
"How Taxes Work" parable. My
qualification for doing so is 25+ years as a tax lawyer.
For those without access to the original essay, here is a
summary: every day, ten men go out to dinner.
The total bill for dinner is always $100, and the bill is always split
the same way. The first four men (the
"poorest") pay nothing, the fifth pays $1, the sixth pays $3, the
seventh pays $7, the eighth pays $12, the ninth pays $18, and the tenth (the
"richest") pays $59. No other information
is given about the men or why they have adopted this strange practice.
One day the owner of the restaurant decides to reduce the
overall cost of the group meal from $100 to $80. The $20 reduction in the price of the dinner
must therefore be distributed among the ten diners. The group decides collectively that they want
to pay their bill "the way we pay our taxes." The first four men
continue to pay nothing. The men first
propose to divide up the $20 windfall equally among the remaining six people
($3.33 each), but that doesn’t work because then the fifth and sixth men would
be paid to eat their meal.
The restaurant owner suggests the following "fair"
settlement: the fifth man pays nothing, the sixth man pays $2, the seventh man
pays $5, the eighth pays $9, the ninth pays $12, and the tenth pays $52. Thus each of the six most well-off diners
have benefited, and the four poorest continue to pay nothing.
You don't have to be Ayn Rand to see where this is
headed. After leaving the restaurant, the
nine men start to grumble that they each saved less than the tenth man, whose
share of the bill was reduced by $7. In
a remarkable display of ingratitude, the first four men, who never paid
anything, complain that they didn't "get" anything at all. "The system exploits the poor,"
they shout! The first nine men then beat
up the tenth man, who staggers off, never to return (in other words, he
"goes Galt").
When the nine men show up the next day for dinner, they find
that they are $52 short of being able to pay for dinner ("Imagine
that!"). (Actually the shortfall
should only be $44, not $52, since there are only nine men dining rather than
ten, but whatever.)
The last two paragraphs are worth quoting in their entirety:
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!
We do not know who these men are, what they each had for
dinner or what their relationship is to each other. We do not know how much money they earn, or
how they got their money. However, in
order to assess the parable on its own terms as a viable model for "how
taxes work," we must make the following assumptions:
- The restaurant represents the U.S. federal, state and local governments
- The men represent the adult populace of the United States
- The meal represents the sum total of the goods and services provided by government to the populace
- The amount paid for the meal represents taxes
paid to the government. These taxes
would include federal and state income taxes (both corporate and personal), federal
estate taxes, Social Security taxes, Medicare taxes, state and local sales
taxes, and a variety of miscellaneous other taxes imposed at all levels of
government such as excise taxes, customs duties, etc.
The parable certainly does provide food for thought, but
that is not the same thing as saying that it accurately describes "how
taxes work." It does not. However, the fundamental flaw in the parable is
not that it fails to accurately describe how taxes work, but that the parable
offers a skewed vision of what government is and does, and what constitutes a
modern civil society.
The first, quite fundamental flaw in the parable as a model
for "how taxes work" is that the payment arrangement described in the
parable not only does not meet the definition of a "tax," it is the
very definition of something that is not
a tax. A "tax" by definition does
not involve a receipt of specific goods and services in exchange for the tax
(i.e., a quid pro quo). A payment for which goods or services are
expressly exchanged is not a tax, it is a fee.
For example, if a municipality requires payment for garbage collection,
the payment is a fee, not a tax. Those
who choose not to take advantage of the garbage collection services need not
pay the fee, while those who do pay the fee have the right to insist that their
garbage be collected.
The parable is written so as to imply that the diners
receive the meal as a quid pro quo
for their payment. This means not only
that those who pay their share of the bill are entitled to be fed, but that any
diner may choose to opt out of the system, as the tenth man eventually
does. This of course is not how taxes
work in real life. People are required
to pay taxes regardless of whether and to what extent the taxpayer receives
goods or services from the government of equal or greater value and, with a
limited exception for expatriates, taxpayers may not "opt out".
The lack of a quid pro
quo is a necessary element in the definition of a tax. Unlike the meals in the parable, most if not all of the services provided by
government cannot be individually doled out to those who pay taxes and withheld
from those who cannot. An obvious
example is defense spending – the benefits of the U.S. military must of
necessity be enjoyed collectively by everyone regardless of how much they pay
in taxes. Even in the case of government
services which can arguably be allocated to specific individuals, such as police,
fire and garbage collection, the populace in general has a common interest in
providing such services to everyone regardless of how much they pay in
taxes. To quote Oliver Wendell Holmes Jr., "Taxes are the price we pay for a civilized society."
The second fatal flaw in "How Taxes Work" is that
the parable implies that there is a connection between what the government
spends its money on, and how the government is funded. Put another way, the parable assumes that
whoever pays the piper calls the tune. In order to understand this point, one
must first understand that, as a matter of both economics and politics,
spending money is exactly equivalent to reducing taxes (thus the term "tax
expenditure"). That is, a decision
by the government to reduce taxes to a class of taxpayers is exactly equivalent
to writing them a check.
Once it is acknowledged that money not collected is exactly
equivalent to money spent, it becomes clear that, in a representative
democracy, deciding how government is funded must be independent from deciding how
government spends its money (which includes the decision of how government doles
out tax benefits). Both decisions are
made by representatives who are elected by the people, each of whom (to simplify
slightly) is entitled to one vote regardless of the individual's income or assets.
A government in which decisions on how to spend money are made by the people that have the money is not a democracy, it is
a plutocracy. Examples of plutocracies
would include the Roman Republic, certain city-states of Ancient Greece, the
civilization of Carthage, the Italian city-states/merchant republics of Venice,
Florence and Genoa, and the pre-World War II empire of Japanese zaibatsus. It would not include the United States of
America at the present time. It is not
clear whether the parable is proposing to ban representative democracy in the
United States.
When viewed correctly in this light, the apparent injustice
visited upon the tenth man (leaving aside the violent reaction of the first
nine men) no longer seems quite so unjust.
If the restaurant and its ten patrons were really an accurate and honest
depiction of society, the ten men would, upon leaving the restaurant, have to
tend to their other needs which the restaurant is apparently not meeting. They would have to feed and clothe their
families, educate their children, find a place to live, etc. Suppose that the nine men, outside of the
restaurant, were living hand to mouth, barely feeding their families, in
serious danger of starvation or fatal exposure to the elements, while the tenth
man was living comfortably. Suppose further
that the restaurant found itself with an extra twenty dollars (the same twenty
dollars which it doled out to the diners in the form of a "tax
reduction"), and decided to give that twenty dollars to the tenth
man. I suspect that even most honest conservatives
would be uncomfortable with that decision (or am I giving too much credit to
the average modern conservative?).
The parable also inaccurately depicts the way our tax system
works because it presumes that each taxpayer derives an equal benefit from the
goods and services provided by the government.
However, because there is no linkage between how a government spends its
money and how it is funded, taxpayers do not derive an equal benefit from the
government. (If they did, taxpayers
would only pay taxes in an amount exactly commensurate with the benefits they
received.) The most obvious example is
that wealthy individuals with substantial assets benefit from police protection
far more than a poor person with no assets.
Thus, in the parable it is presumed that everyone is having
the same meal. If the tenth man were
dining on lobster and champagne, while the nine poorest were subsisting on rice
and beans, the tenth man would look far less sympathetic.
Even if we accepted that the cost of the meal was a
"tax," and that the diners are entitled to receive identical meals in
exchange for their tax payments, the parable is carefully constructed so as to
emphasize the injustice to the tenth man.
This is because the parable leaves out any discussion of the relative income
or assets of the ten men. Therefore, we
cannot assess the relative burden borne by the ten men. After
the adjustment, the tenth man is paying approximately 26 times what the sixth
man is paying. But if the tenth man's
income were 200 times that of the sixth man, the tenth man would actually be
suffering under a much lower tax rate than that borne by the sixth man.
In short, despite its claim to illustrate "how taxes
work," the parable is a grossly inadequate model for the tax system
currently in place in the United States.
The parable misrepresents the nature of tax payments, and the nature of
what government provides in return, solely to make a political point.
However, what is both fascinating and disturbing about the
parable is not its phony claim to accurately describe how taxes work, but the
window that it provides into how the modern conservative views society as a
whole and government in particular. In
the right wing view, government is a mere vendor of goods and services, which
naturally implies that those who pay more should get more. To the modern conservative, the government is
not of, by or for the people, but an independent entity that does not reflect
at all the will of the populace. Government
services are made possible only by the generosity of the rich to the hapless
poor, who have nothing to offer and no role in civil society.
The modern conservative is cut off both from his government
and from his fellow citizens. The rich man in the parable generously funds
dinner for the other nine, and gets nothing in return. In actual society, the
tenth man would be counting on the first nine to serve his food, tend his
garden, clean his house, and take care of his children. They would be his neighbors, his work
colleagues, and sometimes they might even be marrying his daughter. In the parable, none of the men derives any
benefit from the fact that his colleagues are being fed. In real life, every
person benefits from the well-being of his fellow citizens.
Finally, in the mind of the modern conservative, the first
reaction of the underclass to perceived injustice is to resort to violence. This
last telling detail makes it quite clear that the purpose of this parable is
not to illustrate how taxes work, but to demonstrate why the poor should be
grateful for what few scraps the rich choose to leave for them.
