Wednesday, October 15, 2008

Joe Plumber’s Economics

Recently, Democratic presidential candidate Barack Obama got an earful from a plumber in my native Ohio. That plumber, Joe Wurzelbacher -- wouldn't you know, his name is Joe -- was interviewed later by Fox News Channel's Neil Cavuto. It seems that Obama's tax plan for those making over $250,000 a year, would have an adverse effect on small businesses throughout America. And even though those businesses provide a lot of jobs for Americans, what matters most of all here is Obama's stated intentions for redistributing the wealth of America, a plan which amounts to socialism.

Right about now, I wish I were Neil Cavuto, because I could then explain better why Obama's plan is a recipe for disaster. But since I'm not, I'll have to use an example that's been floating around the internet of late. Here we go...

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Let's 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 curved ball (or is that a curved beer!). "Because 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 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 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 me!"

"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 man 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!

Now, there are all kinds of proposals as to how our tax system can be completely overhauled. One is the so-called "flat tax," another is a variation with three levels based on income bracket. There have even been proposals to eliminate the federal income tax altogether, and go with the national sales tax. Some of the states have been using that for years. Then again, they don't have much of a defense budget, do they? All that aside, though, the above 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.


(Tip of the Black Hat to the Pertinacious Papist, who looked the other way when I stole this. As always, I have no shame.)


Dad29 said...

And what does the defense establishment have to do with a sales tax's viability?


The sales tax (consumption tax) is easily the best plan insofar as it penalizes consumption, thus rewarding savings.

Unlike the flat tax, it does not favor the wealthy; and it's quite easy to collect.

David L Alexander said...

"And what does the defense establishment have to do with a sales tax's viability?"

It's simply a major portion of the federal burden, which the state does not have. Still, the premise behind a national sales tax is worth considering. I'm just wondering how much considering it's really getting.

Anonymous said...

In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

This is a proposition that seems straight forward enough, but you run into problems right away. Income isn't created ex nihilo. A doctor could very well move his practice to rural India, put he can't move his salary there. As we go down the line, we find there are quite a few things that can't be moved. Among the things that can be moved there are two ways to address the issue. The most common is tax where the income is produced. For example, if I do contract work in Illinois, I have to pay Illinois income tax on that work even though I live in Wisconsin. The second way is to tax the person where he resides. Needless to say, higher tax states prefer the former method.

The second thing that seems kind of odd is the claim of SB owners having income of over $250K. We aren't talking single proprietorships. Most likely they are using the IBM definition of a small business, under $250MM in revenue. This means we are definitely talking about some sort of incorporation structure, perhaps an S-Corp where income is passed down to the individual to be taxed. Perhaps the taxes force the taking of dividends, thus removing money from the business. Regardless, we aren't talking about Mom & Pop.

David L Alexander said...

Then how does Joe Wurzelbacher put himself in that category, and if you're right, why didn't Obama correct him, rather than launch into his redistribution theory?

Anonymous said...

Digging deeper, it appears he just didn't know what he was talking about. Being on the spot, I don't question Obama for taking him at fair value. He said he was looking to buy a 2-person plumbing shop, one of the employees being him. He said it has income of $250,000-$280K. With two people, let's say he billed 80% of the hours. That leaves 3200 billable hours a year. Taking $250K over 3200, we get $78.13 of pure profit. Oddly enough, the typical plumber bills $75 an hour. I'm guessing he is thinking he is being taxed on his gross income rather than his net profit. Given a typical plumber nets $35,000, his employee should cost him about $70,000, between work comp etc. Add about $10,000 for office and office supplies, another $25,000 in vehicle deprecation, insurance, and fuel, and he is looking at a net profit of about $145K. I'm probably low balling his expenses though. If plumbers made $250K, everybody would be a plumber.

Here he is in another interview:
Eventually it would employ other people. Right now it’s a two man shop and it’s got a very good footprint and a very good reputation, so eventually I would want to put other people out there. I don’t want to get huge because if you get too big your quality goes, but I definitely wouldn’t mind having two good plumbers out there with me working.

Anonymous said...

you are implying that distribution of wealth is the same for everybody the top 10 percent have over half the wealth. So the rich guy is drinking way more beers the then others. your analogy is charming and simple. but this situation is not simple.

integrator said...

I own a business with several employees. I'm an S corp, so all profits funnel through to me. My best year we made (grossed) about $750k. By the time I paid all expenses and employees, I did not make near $250,000 nor even $200,000. In most service businesses your lucky to bill 75% of your time, often closer to 60%. The more service you do, the less billable hours. The more installation, the lower the hourly rate.

But lets say I was making a net profit of $40k per employee (doubtful). So I've got 6 employees and I'm making $240k. If I hire one more guy, I make $280k, but I'm in a higher bracket, so I probably break even, maybe lose a little.

So I either stay at 6 employees, or I hire 2. The 1st is a wash, the 2nd makes me more money. What's the big deal? All it really does is make me try harder to make more money, to offset the taxes.

If you're netting (taking home) $250k or more, think about this. If you're in a room with 100 people, you're probably one of the 5 richest in the room.