Sunday, July 8, 2012

Paying Our Fair Share and Greed ... Saving The Middle Class ... A Story About Normative Economics and Taxes

{NOTE: Oldies but goodies are great. In that vein, the following was originally posted in 2011.

It's one of my all-time favorites. I hope you find it enjoyable and that it prompts you to reflect on fairness, greed, paying our own way, relying on others, name calling, class warfare and many other things, too.

Thanks. Bob.}


Normative economics is about what we believe is "fair", what "should" or "ought" to happen, and so forth. Based on our own beliefs, you may feel strongly that one outcome is fair, while I may believe just as strongly that the exact opposite is what should happen.

When dealing with normative economics, we each believe what we believe, and that's that. There's no objective way to test our beliefs.

Positive economics, on the other hand, is testable. The essential idea is that if A happens, then B follows. In the end, result B may or may not happen, but the theory is testable.

Here's an example of positive economics; If I study harder than I've been studying (A), my grades will be better than they have been (B). Positive economics doesn't mean that B has to be true; it just has to be testable so we can determine if it's true.

Of course, we can't test for what's "fair," since that's based on various value judgments of the different people assessing the situation. That's normative economics.


The following delightful fictional story about taxes was sent to me by a friend. I hope that you will enjoy this lesson in normative economics as much as I did.

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 (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 bar 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 be 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 paid $5 instead of $7 (28% savings).
The eighth now paid $9.50 instead of $12 (21% savings).
The ninth now paid $14.50 instead of $18 (19% savings).
The tenth now paid $49 instead of $59 (17% 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!" "That's true!" shouted the seventh man. "Why should he get $10 back when I only got two? The wealthy get all the breaks!" "Wait a minute," yelled the first four 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 to pay 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 drinking overseas where the atmosphere is somewhat friendlier.

End of story.

Thanks. Bob.

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