Some commentators complain that lower income earners should not be expected to pay the levy and that higher income earners should bear the burden. The counter argument is that through the marginal tax system, higher income earners will automatically pay a greater portion of the cost. For example, someone who earns $250,000 per annum will pay an extra $1,250 per annum in Medicare levy whilst someone earning $40,000 will pay just $200.

The same applies to income tax cuts, where there is always some who will bemoan the fact that higher tax payers receive a higher dollar benefit than lower tax payers. And debates around superannuation stimulate similar commentary, where some argue that higher income earners should not be entitled to receive the same concessional tax benefits to save for their retirement as lower income earners. 

This reminded me of an old anecdote demonstrating how the marginal tax system works…

Suppose that every day, ten men go out for lunch and the bill for the group 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 lunch in the restaurant every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve ball.

“Since you are all such good customers,” she said, “I’m going to reduce the cost of your daily lunch by $20”. So lunch for the ten 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 eat for free.  But what about the other six men?  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 the fifth man and the sixth man would each end up being paid to eat his lunch.

So the restaurant owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and she proceeded to work out the amounts she suggested that each should now pay.

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

Each of the six was better off than before.  And the first four continued to eat lunch for free.  But, once outside the restaurant, the men began to compare the amount they got off.

The sixth man said, “I only got $1 off out of the $20 while the tenth man got $10 off!”

“Yeah, that’s right,” exclaimed the fifth man.  “I only got $1 off, too.  It’s unfair that he got ten times more benefit than me!”

“That’s true!” shouted the seventh man.  “Why should he get $10 off, 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.  This new tax system exploits the poor!”

The nine men surrounded the tenth and told him they were angry that he got so much off while they each got very little.

The next day the tenth man didn’t show up for lunch, so the nine sat down and had their lunches without him.  But when it came time to pay the bill, they discovered something important.  They didn’t have enough money amongst all of them for even half of the bill.

The marginal tax system is designed so that high income earners subsidise lower income earners in providing funding of government expenditure to benefit all. So rather than criticise high income earners, most of whom worked hard to create their wealth, perhaps a little appreciation for carrying the bulk of the burden might be appropriate.

This blog is the opinion of John Hewison as an individual. It does not necessarily represent the views of Hewison Private Wealth. The information provided above is general information only.  It does not consider your needs, financial situation or objectives. You should seek specialised advice from a qualified financial adviser.