Milton Friedman On Government

An educational video providing material for thought. The bright professor Milton Friedman in an interview about taxation, government intervention and many more.

Bar Stool Economics

This fictitious story has circulated a lot through emails, however I find it worthwhile to be posted here. 

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!"
"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, 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.

Past Performance, Future Forecasts, And Taxes

Not surprisingly, the central piece in the talk continues to be the mounting debt and policies that could address that, and more specifically the taxes. The Bush tax-cuts are perhaps going to be the coming election’s campaign theme.

Related to the talk on taxes, WSJ today publishes an article “The Democratic Fisc” which uses the White House’s budget office numbers, published on Friday last week, to have a look at the past performance and future outlook of the U.S. economy. WSJ says “the main message is that tax revenues are smaller, spending is greater, and the deficits are thus larger than the White House has been saying”.

The article compares the current period with the 1981-82 recession which is similar in its severity with the one the current administration inherited. What strikes me are the following differences between these two periods:

	1981-1987	2009-20012
Budget Deficit:	less than 6% of GDP	current 9.9% of GDP, it is expected to rise to 10%, before it declines to 5.6% of GDP
Revenues:	17.3% of GDP, despite pro-growth tax cuts	14.5% of GDP, expected to increase to 15.8% in 2011 when big tax increases hit
Policy:	tax cuts across-the-board	spending, temporary tax rebates, jobless benefits

The findings, from the above table, clearly raise the long debated question about the effectiveness of spending and tax cuts. I will return to this later.

Some other factors that enhance the bleak future economic outlook are described by (1) the expectation that deficits will not shrink bellow 3.4% of GDP over the next ten years, (2) the ratio of debt-to-GDP will continue to increase over the same period, (3) there is no plan yet to fight debt, (4) spending is expected to increase and (5) taxes are increasing -- this is not a request of the fiscal commission, which means that perhaps more taxes are coming.