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post #1 of 3 Old 08-03-2007, 11:17 AM Thread Starter
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How Income Tax Really Works

Don't know how accurate this is but it sounds right and was written by someone who knows more about it than I do.

This is a very good explanation of how income taxes really works!! Sometimes politicians, journalist and others exclaim, "It's just a tax cut for the rich" and it is just accepted to be fact. But what does that really mean? Just in case you are not completely clear on this issue, I hope the following will help. Please read it carefully. It puts tax cuts in terms everyone can understand.

Suppose that every day, ten men go out for dinner and the bill for all 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 ate dinner in the restaurant everyday 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 meal by $20." Dinner 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 eat 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 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, 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 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. 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 me."
"That's true!" shouted the seventh man. "Why should he get $10 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 the tenth man 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 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 eating overseas where the atmosphere is somewhat friendlier.

David R. Kamerschen, Ph.D
Professor of Economics,
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post #2 of 3 Old 08-03-2007, 3:37 PM
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Re: How Income Tax Really Works

I saw that around a decade ago. Also look at the percentage saved, the 10th guy got the lowest percentage.

People also don't realize that when it comes to tax cuts, what is actually done with the money. When Bush cut taxes my business partner hired two additional people. The two people cost more than the tax cut but was a way to expand the business for a little increase in expenses. If taxes goes up, he may have to let one or two people go. He could raise prices as well, but in the medical industry not the easiest thing to do as insurance companies pay X amount. He also does medical services for free to people that can't afford cardiology.

Just two examples why higher taxes don't benefit everyone and can actually hurt.
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post #3 of 3 Old 08-04-2007, 10:37 PM
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Re: How Income Tax Really Works

A professor of economics who doesn't know a thing about the tax code...Income taxes tax INCOME, not wealth...The truly wealthy gat very little "income," and so pay very little in taxes. Sure, there is a group that makes a lot, and pays a lot too, but remember that Economics is a social science based on "assumptions." The assumption that a "tax-break" is even/equal across tax brackets is false. Just like different levels of adjusted gross income produce a different rate of taxation, so too the "breaks" or reductions are graduated also.
Plus, the breakdown of the costs between the ten men is flawed...There is a bell-curve of normal distribution around the mode-value of average income in this country, and that means a greater burden is borne by the middle few "men," as that group of men is actually larger than the 30% of the population that the example seems to indicate...It is a very sexy "story" but long on rhetoric and short on actual data. I refer folks to the IRC if they want to learn how taxes really work...
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