Bar Stool Economics

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Something they don’t teach at Business School (or in Washington).

Our Tax System Explained: Bar Stool 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 pay $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 got’

‘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, ladies and gentlemen, 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.

David R. Kamerschen, Ph.D.
Professor of Economics
University of Georgia

HT to Lisa

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40 replies
  1. Cathy Couey
    Cathy Couey says:

    That was the best explanation I have ever heard. I commend you and I thank God for giving it to you to explain in such clear analogy. Keep up the good work.
    Sincerely,
    Cathy

  2. Mark
    Mark says:

    Larry,

    That’s because its OVERsimplified.

    Cathy,

    The BEST explanation you’ve ever heard? Really? If that’s true, then either 1) you’re looking in the wrong places, or 2) you don’t want a real explanation unless it fits your opinions about what you hope is the real explanation.

    Its a clear analogy because its dumbed down as much as possible.

    1. A progressive tax policy is generally regarded as better for everyone (rich and poor) and is supported by both parties.
    2. 99% of the people that read this are NOT the rich person that gets beat up. Most people read it and think that they are, even more people read it and think that they will be one day.
    3. taxes under reagan, clinton, bush, and obama will all fit this example (under the oversimplified terms of this analogy, party is not a factor).
    4. who’s really beating up the rich person? oh those poor downtrodden rich people! the poor get all the breaks!
    5. remember that only in america can a poor person become a rich person. this is largely due to the opportunity afforded to those with little – largely because of our PROGRESSIVE TAX POLICY.

  3. Dr.Bruce
    Dr.Bruce says:

    I don’t think analogy is promoting a regressive tax system.

    While it is very simple, I have talked to dozens of people that are shocked to learn that about 40% of the population pays no taxes at all.

    The analogy works perfectly at the three main points of the story. First, the distribution of taxes paid by Americans is very close to the numbers mentioned, which as I said before, is illuminating to most people. Also, businesses and individuals will take their wealth to the place they can receive the lowest taxation, especially if they are vilified for their wealth. Did you know that the USA has one of the highest tax rates in the world on corporations? Finally, it is rather silly to call it a tax rebate and give any it to the 40% that do not pay taxes. That is welfare.

  4. Sidd
    Sidd says:

    The thing missing from this oversimplification is that the richest man is not just making slightly more than the other nine – he’s making VASTLY more. So much so that the taxes he is paying is pretty much chump change.

    Additionally, quite a few of them (the richest guys) DO hide their money in overseas tax shelters and have for years avoided paying taxes to the country (ours) that allowed them to build up their staggering wealth. Ingrates.

    Whereas the richest guys tax break would allow him to buy mansion number 2, 3 or 7 the tax break on the bottom guys pretty much amounts to another trip to McDonalds. Yes. Oh so fair. Poor poor widdle rich people.

  5. Tim
    Tim says:

    But don’t those poor exploited rich folks account for something like 97% of the money earned here in the mean old US of A? Let them take their money and drinks in “friendly” Europe, they’ll be paying a WHOLE lot more in taxes there, besides having far less of a chance to earn the kind of money that can be made in America. If you want to live in the greatest country on Earth, be willing to pay the admission fee. Spend some time in an inner city school and see just how “advantaged” the poor really are as compared to the wealthy.

  6. Dr.Bruce
    Dr.Bruce says:

    Gee Tim, one would almost think you had actually read the story. Of course wealthy people will take their money and go elsewhere leaving the middle-class unable to pay for the enormous burden of the poor.

    The top 1% of wealth pays for approx 25.6% of taxes. Further, the top 25% pay 80% of ALL taxes.

    Can’t make as much elsewhere? That contradicts your basic argument.

    Be willing to pay the admission fee to live in America? I totally agree. I just want everyone to pay a fair share of the fee.

  7. Jamie
    Jamie says:

    Ha!

    My favorite line is right here:
    ‘Wait a minute,’ yelled the first four men in unison. ‘We didn’t get anything at all. The system exploits the poor!’

    My mother is an accountant, so this time of year, I can’t call her without hearing the stories of people and their taxes. She gets so frustrated with people coming in and spending half of their earned income credit to have their taxes done just so they can get the money that day!

    It all boils down to knowing how to use your money, doesn’t it?

  8. JenniJ
    JenniJ says:

    Wow….That’s a really great way to explain how the tax system works. It would be funny if that’s actually how bar bills were split…I can only imagine the fights that would take place. Great article.

  9. French Citizenship
    French Citizenship says:

    I think that this is way over simplified and it makes the middle wages men and the poor men look like they are greedy and paints a picture of a rich man being good an honorable and very giving with this tax money, but in actuality look what happens when you give the wealthy a choice.

  10. Sushi Freak
    Sushi Freak says:

    It sounds good, but that’s why Dr. Kamerschen should be ashamed. Not only is this dreadfully oversimplified, but the use of beer as an analogy is also a sophmoric attempt to propagandize what the Professor probably views as “Joe Sixpack.”

    But if we’re going to use this, let’s propagandize it right.

    The men don’t directly pay for the beer, they just hand the bar tender the money and he decides how much and what kind of beer they get. The richest men don’t actually drink much of the beer, since they buy their own premium beer. They just hand their cash to the barkeep in hopes that the drinkers will not get rowdy and hit the streets with torches and pitchforks.

    One day the rich stop paying, since they aren’t drinking anyway. And the others, believing they have no way of obtaining beer, riot and loot and go on a crime spree. So the rich men pay for more police and more prisons.

    After many years, they realize that the cost of beer was only a fraction of the cost of prisons and cops. They also realize that paying for decent schools would have lessened the need for beer overall.

  11. Dr.Bruce
    Dr.Bruce says:

    Greetings all.

    OF COURSE this is a simplification. Therefore, certain readers should not make complicated inferences to prove that the story is … well … simple.

    The point is that a growing percentage of our population pay NO taxes. What happens when that group represents more than half of the country? Further, when we take money out of the treasury (by borrowing money) and send it to people that pay NO taxes, that is not a tax cut, that is socialist welfare. The current OMB agrees with me on this and call it ” new spending” rather than a tax cut.

    We are creating a welfare state where, for many, it is much easier to live off the government than it is to get an education – which is why the schools are failing as opposed to the popular idea that we don’t pay teachers enough.

  12. RWNJ
    RWNJ says:

    Always loved the bar stool economics story. 🙂

    People who think taxing the rich only hurts the rich are quite naive. Some people are wetting themselves over this $13/week tax cut but don’t realize that they’re going to pay out more than that in extra expenses.

    Think about it, you’re the evil rich person and run a company. You just had your taxes raised on you and your company. What do you do? You consider it an additional cost of business and add it to the cost of the items/services you provide. The rich don’t pay the tax hikes on the rich, the average consumer does. It’s a shame so many people are ignorant of this and refuse to think it through.

    Throw in all the additional taxes on the table (beyond th bailouts and welfare changes)… For instance, proposed carbon taxes will raise the average electric bill by $240-$1000/year.

    Who’s interests are these tax hikers looking out for? It certainly is not the “middle class”. They are simply exploiting ignorance in order to look like heroes for “taxing the rich”.

  13. Angela Wenke
    Angela Wenke says:

    WOW that was quite and eye opener. What a wonderful article it really did show how tax breaks effect the wealthy and he is right. If they are going to pay too much in taxes living in the US they are simply going to pick up and go somewhere else since they can afford it!

    Great article!
    Angie

  14. Liane
    Liane says:

    And I’m starting to wonder how the whole system really works. I’ve read the post same with the comments and I say thank you for clearing a lot of empty spaces in my mind.

  15. Dr.Bruce
    Dr.Bruce says:

    I think everyone should read the story of the goose that lays a golden egg. And then wonder how long it will take President Obama to kill it.

  16. Attila O.
    Attila O. says:

    Thanks, this was quite clear and easy to understand.

    When I was watching the movie “The Corporation”, I was stunned by the theorem, that if the world’s population would be 10 people, 4 or them would have TVs in all his rooms, ant the other 6 wouldn’t have a TV at all (actually some wouldn’t even a home).

    But this story makes it a bit clearer. Shows things from another perspective. I’ll have to tell my friends over the University of Economics and Law.

  17. Bret
    Bret says:

    Regardless of how taxes affect rich or poor, the rich are the only ones in this country who would have the ability to turn the economy around. Having millions upon millions (sometimes billions and more) stuffed away in foreign accounts or banks scattered all throughout the country could more than pay off the country’s deficit. Now I understand that everyone has worked hard for their money, but whatever happened to patriotism? Does that only apply to war times? Or having a colored ribbon on the back of their huge SUV?

    If everyone who literally put $100 million or more a year in their pocket, instead donated $50 million to the US government, what would our deficit be like then? You can’t tell me these guys need $100 million + in order to survive.

    Stop buying hundreds of sports cars and houses all over the world and help out the country and aided you in making you the rich man you have become.

    And stop complaining about being taxed so high when you can actually afford it. If I could pay off a large percentage of the deficit and aid in the turnaround of this economy I would, but unfortunately my measly $20K a year doesn’t quite do much more than pay bills.

  18. Details
    Details says:

    I have to agree with Sidd. The fact is, without the poor, there would be no wealthy ones. Who buys their products? Who creates their products? This world is of unfair distribution, yes. But I always argue that the rich or the wealthy is not to blame as well. For sure they spend effort or whatever to reach their current status. they might even be peasants in the past!

    The truth is, there is no perfect system unless everyone agrees to it. Let’s face the truth that we have differing ideas and harminy is very difficult to attain. The story above just made it swayed in favor of the rich man…. if that 10th person has machineries, connections and everything, it’s not his fault… But all the same, great power, money and blessings means also a responsibility to your fellows.

  19. Jack
    Jack says:

    The Bible says the poor will always be here and history bears this out. At least they get to drink beer.

  20. danalamano
    danalamano says:

    The guy that has been paying the lions share for the entire time got a bigger break in numbers, but the smallest percentage over all. People need to open their eyes to it!

    I, for one, think that everybody should pay his or her fair share! This is a perfect argument for a fair tax type system.

  21. Developerholic
    Developerholic says:

    Whoa! Great analogy, I haven’t thought of that. Honestly, I did not know how our tax system works. i just pay them whatever amount they asked me too.

    Anyway,Im still single but when Im married or have children, things might have changed for me.

    Cheers,
    Meg

  22. Dr.Bruce
    Dr.Bruce says:

    You would make a different choice? I doubt it.

    A primary point of the story is to illuminate the silliness of ‘tax rebates’ for people that pay no taxes.

  23. Erik Hanson
    Erik Hanson says:

    Wow, a lot of people here seem to be under the impression that those *evil rich people* just created their riches out of thin air by enslaving the poor.

    Who would have guessed that by lowering the bar bill that the tenth guy pays, he actually ends up hiring two of the others to help him carry the beers for the group. You can probably think up some other witty beer-related analogy related to the rich owning businesses, including many of the small businesses that make up the bulk of American jobs, and how we’re really punishing some of the hardest-working members of our society, and thus ourselves, with this asinine tax system.

    And finally for those complaining about the poor lower classes, it’s not like welfare just emerged in January 2009, again, out of thin air. Anyone, no matter their income level, should be able to leave a legacy to their children. Instead of using their negative tax payments to get out of debt, saving up for their kids’ college and their own retirement, and leaving an inheritance so their kids have it better off than they did, it seems like the poor are content to stay where they are at financially, wait for a handout from the tenth guy on one side, and spend 100% of their earnings on “essentials” like payday loans, iPhones, HBO, and beer, using the other hand.

  24. Tungsten Carbide :
    Tungsten Carbide : says:

    bar stools should always be made from stainless steel or chrome plated metals for durability.*-

  25. Rick Hanlon II
    Rick Hanlon II says:

    Though I agree that there are way too many people who pay no taxes, there are a few important issues with the analogy:

    One: Everyone is forced to go to the bar. It’s a subtle difference, but makes an impact on the analogy. It corresponds to the idea that if you live here, you pay taxes here.

    Two: They do not pinpoint exactly the extent of how rich everyone is. Guy number 10 is as wealthy as the other 9 guys combined, while guys 1-5 make only 10% of the total wealth.

    That is, to scale, every day all 10 guys make about $580:

    Person Makes
    1-5 $74
    6-7 $116
    8-9 $124
    10 $266

    Now, let’s re-examine the data with this in mind.

    To pay for the bill equally ($10 each) would require:
    Person Income Paid
    1-5 67%
    6-7 17%
    8-9 16%
    10 3.8%

    Note: I know that no one is advocating dollar amount equality, but it is illustrative.

    Now, let’s say that everyone is required to pay 17% of their income for the tab:
    Person Pays
    1-5 $12
    6-7 $20
    8-9 $22
    10 $46

    Interesting. Now let’s consider that, since 17% of income from person 1-5 significantly inhibits their ability to even make an income to begin with, persons 1-5 pay nothing. Then, the other 5 people pay 20%
    Person Pays
    1-5 $0 -12(16% of wealth)
    6-7 $23 +3(2.5% of wealth)
    8-9 $25 +3(2.4% of wealth)
    10 $52 +6(2.25% of wealth)

    Interesting. Even with the bottom 5 people paying nothing at all, the wealthiest person still pays LESS than in the current tax system. However, persons 6-9 pay more.

    Now, let’s say that the bill is reduced to $80 (maybe the bar owner gave up his 10 year feud with the neighboring bar owner). Then everyone would be required to pay 14%:
    Person Pays
    1-5 $10
    6-7 $16
    8-9 $17
    10 $37

    Or, with person 1-5 paying nothing, 6-10 pay 16%
    Person Pays
    1-5 $0 -10(13.5% of wealth)
    6-7 $18 +2(1.7% of wealth)
    8-9 $19 +2(1.6% of wealth)
    10 $43 +6(2.25% of wealth)

    So, as the data shows, a flat rate is certainly fair and the issue to argue is certainly not that the bottom 5 people pay nothing *When you consider the disproportionate amount of income each person makes*.

    Also, the crux of the article involves the middle and lower class complaining about not getting enough benefit out of the tax cut. No one is making this argument. The argument is in cutting the upper incomes taxes exclusively. That is the notion of ‘trickle down’. It would be like giving all 20$ to only the tenth man (a 34% savings!) . It is laughably ridiculous, and that would certainly cause the men to become outraged outside. They would argue “We are forced to come to this bar, and we pay our fair share, but you get to pay less because you make the most!? That is ridiculous!”

    The analogy confuses, as everyone on the for-rich-tax-breaks camp does, the difference between paying a fair percentage and the corresponding dollar amount. Of course the top 10% will pay 60% of the taxes when the top 10% makes over 60% of the income!

    There are too many people though that think they are educated by facts and are actually falling into the propaganda trap.

    This was fun. What do you think?

  26. Sourabh
    Sourabh says:

    @Rick Hanion:

    Awesome reply…..

    I know many people forget that income distribution. The beer economics is an illusion. Wealthy have got their wealth because those 1-5 works their assess off for the wealthy. Then middle those poor and middle class bought those products. All work and price money went to rich.

    This stupid beer economics doesn’t mention that. …..

  27. dannymichelle7499
    dannymichelle7499 says:

    All those socialists whineng about how the rich guy gets rich off the welfare ‘worker’ … what risk did the welfare workers take – the 4 and then later, 5 that paid no taxes I mean got free beer didn’t risk anything they put their blood, sweat or tears into building or creating or drinking.

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  1. The Angry White Guy » Blog Archive » The truth of FDR legacy says:

    […] how the Democrats can exploit the tax cuts for the rick argument, it is no better defined than in Our Tax System Explained: Bar Stool Economics Go read it now, I’ll wait here …. ok you’re back let’s […]

  2. The truth of FDR legacy - The Angry White Guy says:

    […] how the Democrats can exploit the tax cuts for the rick argument, it is no better defined than in Our Tax System Explained: Bar Stool Economics Go read it now, I’ll wait here …. ok you’re back let’s […]

  3. […] Our Tax System Explained: Bar Stool 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…” […]

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