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Marks and the tax system explained in beer

As a follow up to Dr Rodney Brown's article last week on taxing the rich and the subsequent lively discussion, we republish Oaktree's Howard Marks and the 'beer' example to explain the tax system.

***

The following explanation of the tax system has been popular for many years, and in his this client memo, Oaktree's Howard Marks quotes it and says,

"I've been waiting a long time for a chance to use this. The numbers may not be exactly right but the idea is. The unarguable bottom line is that everyone's view of the fairness of the tax system - like most such matters - depends largely on the angle from which you look at it."

Here is an example of the beer explanation:

"Suppose that once a week, 10 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.
And the tenth man (the richest) would pay £59.

So, that's what they decided to do.

The 10 men drank in the bar every week and seemed quite happy with the arrangement until, one day, the owner caused them a little problem. "Since you are all such good customers," he said, "I'm going to reduce the cost of your weekly beer by £20." Drinks for the 10 men would 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 realised that £20 divided by six is £3.33 but if they subtracted that from everybody's share then not only would the first four men still be drinking for free but the fifth and sixth man would each end up being paid to drink his beer.

So, the bar owner suggested that it would be fairer to reduce each man's bill by a higher percentage. They decided to follow the principle of the tax system they had been using and he proceeded to work out the amounts he suggested that each should now pay.

And so, the fifth man, like the first four, now paid nothing (a 100% saving).
The sixth man now paid £2 instead of £3 (a 33% saving).
The seventh man now paid £5 instead of £7 (a 28% saving).
The eighth man now paid £9 instead of £12 (a 25% saving).
The ninth man now paid £14 instead of £18 (a 22% saving).
And the tenth man now paid £49 instead of £59 (a 16% saving).

Each of the last six was better off than before with the first four continuing to drink for free.

But, once outside the bar, the men began to compare their savings. "I only got £1 out of the £20 saving," 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 £1 too. It's unfair that he got 10 times more benefit than me!"

"That's true!" shouted the seventh man. "Why should he get £10 back, when I only got £2? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison, "we didn't get anything at all. This new tax system exploits the poor!" The nine men surrounded the tenth and beat him up.

The next week the tenth man didn't show up for drinks, so the nine sat down and had their 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 to pay for even half of the bill!

And that is how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy and they just might not show up anymore. In fact, they might start drinking overseas, where the atmosphere is somewhat friendlier."

 

26 Comments
Kevin
February 21, 2021

I've always looked at it as,if I pay a lot of tax,it means I've got a lot of money in my pocket.

Wish I was paying a $ million a week in tax .

Janice Sengupta
February 19, 2021

Here’s an idea, why not give the £20 savings to the four poorest (£5 each) who can than each pay the £1 for beer and use the other £4 to invest in themselves (job training, education, better clothing, creation of a start up) so that they become less poor. This is a Pareto improvement.

And, if the poor are successful with their initiatives, they can start to pay their own way and everyone can share in the discount.

Kevin
February 22, 2021

How do you give a tax cut to people that don't pay tax? Being self funded as a retiree and means tested out of everything I get no help from the govt.I save them around $36K on the pension Then I pay tax on my investment income . Suppose my input to the govt is $100K annually,people will still tell me that that must be because I cheated,that must be because of tax avoidance,and anything else they convince themselves is real,no matter how obvious it is that is far far away from reality. I get a tax cut,how does the govt share a few thousand amongst millions of people that don't pay tax. For the whole of my life I have been amazed at why people aim to be poor.Convincing themselves that " rich" must mean because you cheat on tax.Convincing themselves that they would be better off if they paid less tax. Looking at me as if I am weird when I tell them do not enter into tax avoidance schemes.If you want to pay less tax,earn less money.If you want a lot of money,earn more money,and you'll pay more tax .


Somehow I am supposed to believe that if someone retires with a big shareholding, somehow they dodge tax. The shareholding is printed in the annual report.The registry informs the tax office of how much dividend he has been paid.The tax withheld from the 40ish% franking credit,and do people really think the tax office know nothingg of this,because he hired "clever accountants"etc.Somehow the tax office is not interested in his $6million of income because it is only the low paid worker that pays tax,they subsidise the rich,dear me.


Looking at numbers as Graham has if I am told that say 10% of earners pay 80% of tax,I believe it. All I have to do is look at my surroundings Retired,I pay tax,I don't know anybody that I worked with of my age that pays tax.They all get a pension or part pension,and I never stop laughing at them when they tell me that I am the person that is a drain on the system,not paying my way,how guilty I should feel for cheating them,I am the person stopping them from getting more out of the govt . They spent the whole of their lives aiming to get a part pension at least,no matter how many times I told them try to retire on a 6 figure net income,the answer is the same.Would that not stop me from getting a pension,why would I do that,I want that money off the govt,I deserve it. The level of financial knowledge is non existent.When I worked a 40 year old man was put on to me. He worked overtime on Saturday and complained long and loud about how he paid $100 more in tax,he would never work overtime again. With penalty rates he earned $300 for the Saturday work.He paid $100 in tax,and was $200 better off.He seemed to have no idea how much went into his bank account.All he saw was he paid $100 more in tax than the previous,it is rich people to blame that he is worse off. Tax deductions.A man the same age as me had the best tool box I have ever seen,every tool imaginable,most of them not needed.Because it was a tax deduction.He spent his entire life convincing himself that if he spent $450 on a tool,the tax office gave him $450 back as a rebate,because it was a tax deduction.Explain to him that the tax paid on that $450 would be refunded and he would not have a bar of it .


Working as a tradesman for my working life,these thing are normal.These people have themselves convinced that they know about tax systems,investing etc.They know they are right because other people agree with them ,mostly.Anybody that disagrees with them is obviously wrong,to them. Bit of a rant but! I have read that article many times over the decades,with slight variations.As a generalisation of a tax system I think it does a good job of explaining it.

Bart
February 19, 2021

Might I suggest that the simplification of complex issues like inequality in all forms to a dichotomy between a progressive and a less progressive tax system ignores far more important matters of substance in people's lives. While our tax system is structured so that indirect taxes are the same for the rich and the poor there will continue to be widespread disadvantage for many. GST is designed so that rich and poor alike pay the same tax rates on the fundamentals of life such as food etc. A progressive tax system, one which the rich continually try to devalue, is the cornerstone of a system based on decency, fairness and a commitment to the less fortunate. This is a concept which many in the Liberal party have some difficulty in sympathising with.

Andy
February 21, 2021

When gst was introduced pensions, other taxes / duties and subsidies were increased (or decreased depe ding on which it was) to make sure that GST didn't become a regressive tax.

In the past I would have agreed with you (that it was regressive) but after doing the research about the other changes that occurred at the time I now know that this isn't the case.

Chris
February 22, 2021

Were SUPPOSED to. Stamp Duty on properties in SA was supposed to disappear with the advent of the GST and never did...

Simon Taylor
February 21, 2021

Yeah, but we don't pay GST on essentials like food or health care. And those who consume more expensive goods pay more tax.

Geoff (the other one)
February 19, 2021

Why is it whenever this example comes up, people come out of the woodwork with vague implications about tax rorts by business owners and corporations paying zero tax despite income of $X,000,000... Irrelevant.

These are all salary and wage earners in different jobs, having a beer after work. And on that basis, it's a pretty good example.

The G
February 19, 2021

In both examples above, there is £1 pound missing from the sums.

Graham Hand
February 19, 2021

Hi The G, there is £1 'missing' from the second example, I assume, for rounding reasons. It's not missing from the first. It doesn't change any of the arguments.

GG
February 18, 2021

When big business has unreasonable taxation, wages conditions etc. forced upon it there is incentive to relocate. You may have noticed the odd business has outsourced back office work to India, call centres to the Philippines, manufacturing to china or totally departed Australia. This not only reduces the tax take but puts more on welfare. the rich need to pay their fair share but the wingers need to stop looking for someone else to pay their way

Richard Wishart
February 18, 2021

There is of course an element of underlying truth in the beer tax system humour. There are also many misconceptions relating to taxation and this is hardly a surprise considering the thousands of pages of legislation, tax rulings, case law and technical commentary. When seven High Court judges often disagree as to the meaning and effect of the law, what hope for the rest of us?
Despite the issues of fairness relating to taxation and the redistribution of wealth, the system has come a long way from Federation when at that time Australia's tax to GDP ratio was about 5%. It is now closer to 30%. The federal government first introduced income tax in 1915 as a temporary measure to fund the war effort with a top rate for the wealthy of 25%. It's a salutary lesson that one should be wary of temporary measures when they relate to taxation.
On the subject of fairness and human well-being, I recommend to my fellow Morningstar subscribers and the Morningstar team that they read the recently published book "Enlightenment Now" written by Steven Pinker recording the extraordinary gains in human well-being on every conceivable measure applicable to both the wealthy and poor over the last couple of hundred years, and how it is important that we don't take for granted the system that has made these gains possible.

Trevor
February 18, 2021

Apologies Graham : The Commonwealth used the CAPITAL LETTERS , and I just copied their data.
I am NOT shouting ! I am supporting YOUR reply to Peter in the article above.
.
Composition of Australian taxes: 39% PERSONAL TAXATION , 19% STATE & LOCAL TAXES , 19% COMPANY TAX,
12% GST and OTHER FEDERAL TAXES 11%.
.
Of the 39% PERSONAL TAX , 50% is paid by the TOP 10% of INCOME EARNERS.
"When I restricted the STINMOD base population to the working age population only (aged 18 to 65) and rank these people by their taxable income, I found that the top 10% (those with taxable incomes beyond $102,000 per annum) do pay around 52% of all personal income taxation."
"The Treasurer’s statement that the top 10% of incomes from working age persons pay 50% of personal income tax is correct."
"I agree with the author that the FactCheck demonstrates Australia’s progressive income tax system, which has long been considered fair."
"Australia has a high tax-free threshold of $18,200 so many working age low earners pay very little income tax.
In contrast, New Zealand taxes from the first dollar of income.
And many working age people pay no income tax simply because they are unable to find a job - as Australia has an adjusted 6% unemployment rate."

Peter N
February 18, 2021

Nice simple analogy, pity it bears little resemblance to reality.
The top richest people pay very little tax as is reported by the ATO with the effective tax rates of the top companies in Australia.
The funny thing with cutting taxes used to provide services is the cost recovery efforts targeting the users with rising access fees, application fees, copayments etc.
An increasing tax burden on 'consumers' by another name.

Graham Hand
February 18, 2021

Hi Peter, In Australia, the Top 1% earners of reported income pay 39% of income tax which is more than the bottom 90% pay, and the Top 10% pay 70% of income tax. Does that sound about right, or do you think they should pay more?

Geoff
February 18, 2021

Thank goodness we have people like you Graham to correct the falsehoods such as what Peter N promotes!

Peter N
February 18, 2021

Funny thing about income and reporting.
Trusts and other beneficial legal structures can skew numbers considerably.
How else can corporate entities report tax paid approaching 0. They are not altruistic entities running a business for no gain.
If you turned the numbers to look at the wealth of the top 1% vs the bottom 90% then maybe the 39% share of income tax doesn't look nearly so bad.

Dave
February 18, 2021

Whatever happened to fairness and compassion. When I was young I was taught that a scaled tax system was inherently fair. The rich were still better off than others and the system looked after those less well off. Now it seems everyone just wants to look after themselves and decries any attempts to ensure fairness by having a progressive scale tax system. When are we going to get it through our heads that lower taxes mean lower services. Do we want a US system where the rich are quite happy but the poor can't afford health care or an education that could lift the next generation from poverty.

Georgina
February 18, 2021

Dave, please read Graham Hand’s comments above. You can’t tax the top 10 or 20% of tax payers into oblivion. The problem is the ‘services’ that government provides continually expands and more people (even people securely and well employed) want more ‘stuff’ for free from the government. There is a huge safety net paid for by the minority of tax payers. The bottom 50% of earning households pay no net tax once transfers are taken into account.

Keith
February 18, 2021

That’s how the Labour Party gets elected!!! Love it.

Mark Hayden
February 18, 2021

My thoughts are that the richest man would have had a team of Accountants and Advisers to ensure he paid minimal tax in the first place. And when tax breaks were announced they would have worked hard to ensure he benefited again. But they are just thoughts.

Malcolm Wilson
February 18, 2021

Always remember what Kerry Packer said to the Parliamentary Committee on Print media in 1991. Of course I'm minimising my tax. If anybody in this country doesn't minimise their tax they want their head read. As a government I can tell you you're not spending it that well that we should be paying extra."

john
February 18, 2021

Your right Mark !! the above article does not take into account all the loopholes being rorted by many of the richest; such as hidden off-shore, minimisation structures (corporate and trustee), company deductions etc etc.

John
February 18, 2021

The US is living this out as we speak, with high tax states like California, Illinois and New York chasing away their highest tax payers who decamp to low tax states like Florida and Texas. The high tax states respond by increasing taxes further, thus creating a vicious circle. They then ask their fellow Democrat Joe Biden to bail them out using Federal funds, effectively asking the low tax rates to subsidise them.

rtts
February 18, 2021

Not so. Cal, Ill and NY are among the most productive states which subsidize the less productive, poorer states (i.e., they make net taxes to the Feds less Fed grants back to states) while the less productive, poor states get back from Feds more than they pay to feds). This is a massive subsidy.

Add to that Trump's tax "reform" greatly reducing the Fed tax deductions for state and local income taxes (yes, in US most states and many cities have their own income taxes) which disproportionately impact taxpayers in the productive states where locals pay for their own services rather than live off Fed government. Thus, the low tax "taker" state are not in any way asked to subsidize the "giver" states. Simply a long time unheard of ask from states that have paid their own bills for a little back from Feds.

Don't fall for the Trump's "alternative facts" from which I suspect that John picked up this idea. Not coincidentally, Cal, NY and Illinois and most other "giver" states are Blue (Dem) states and most "taker" states are Red (Repub). Welfare for the welfare haters.

Admittedly, that still leaves Florida and Texas that are low tax but growing states, but still only in the middle of the giver-taker ranking despite their wealth - which indicates that they still rely on Feds for many programs because their own productivity doesn't pay for everything. Look at Kansas experiment where taxes cut big time a few years ago - not only no economic boost, but fell into economic hole. So-called "supply side" economics doesn't work.

Adam
February 18, 2021

That is absolute gold!

 

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