The Parable of the Ginis

The trouble with taxation and redistribution

I want to tell you a parable. Like any good parable, this one has a moral. And, like any good parable, this one ought to be retold. When it comes to parables, sometimes it’s hard to find the original teller. Luckily, in this case, we know the author. So, in the timeless tradition of parables, I am stealing this one from Kip Hagopian. I’ll keep the skeleton of Hagopian’s story and change the flesh a little to keep things interesting.

Hagopian’s parable

Once upon a time, there were three sisters:  Tara, Lara, and Sara Gini. They were triplets, and each was 40 years old. Having been raised in the same home, these virtual genetic duplicates had the same basic aptitude. As it happens, each sister grew up, got married, and had two kids. All three were nurses making $25 an hour. They each worked 50 weeks a year.

Although they were all pretty smart and had basically the same level of education, they differed in their work preferences, or what some might call “work ethic.” Tara worked only 20 hours a week. She had a completely different work ethic from her sisters Lara and Sara, who each worked 60 hours per week. Neither Tara’s nor Lara’s husbands worked. In fact, Tara’s husband was what you might call a layabout, while she was an avid stamp collector. Meanwhile, Sara’s husband worked 40 hours per week as a writer making $50,000 per year (the same hourly rate as his wife).

Tara and Lara spent all of their income and relied on Social Security checks to maintain their lifestyles at retirement. By contrast, Sara and her husband saved a lot of their after-tax income over many years, eventually amassing $300,000. They put this money into an investment portfolio that ended up producing $25,000 a year in interest and additional income. So, the financial breakdown of each family looks like this:

 

Tara’s Family

Lara’s Family

Sara’s Family

Work hours per week

20

60

100

Annual Salary

 

 

 

Wife:

$25,000

$75,000

$75,000

Husband:

 

 

$50,000

Investments:

 

 

$25,000

Total Income

$25,000

$75,000

$150,000

 

Despite their different work and life priorities, the Gini families were close. The Ginis were so close, in fact, that when a new residential development was built in their town, they each bought a home on the same private street. Each house cost the same. Their three houses were the only ones on the street.

One day, the sisters decided to pool their funds to improve the street. They were concerned about crime and safety, and they all wanted a more attractive setting for their homes. So the three families decided to install a gate at the street entrance, add lighting for additional visibility and security, resurface the street, and landscape the area to improve the drive up to their homes. All the work cost $30,000.

The sisters were quite happy with the outcome and all felt $30,000 was reasonable given the benefits to everyone on the street. When it came time to divide up the bill, however, the problems started.

Sara thought matters would be easy. Because the benefits to each family were the same, each sister should pay one-third — about $10,000. But Tara and Lara objected.

“Why should we pay the same amount?” Tara and Lara asked. “You make much more money than we do.”

Sara was puzzled. “Why is that relevant?” she asked. “Our family makes more money than yours does because my husband and I work longer hours and earn extra money on our investments. Why should we be penalized for working and saving?” Sara looked at her sister and said, “I’m no smarter or more talented than you are. If you and your husband worked harder and saved more you’d make as much as my family does.”

To this, Tara replied: “I don’t work more because I like my leisure time. I don’t save because I want to have things today. Why have things when I’m too old to enjoy them?” Tara was indignant. How could Sara — who was “rich” — ask her to pay the same amount when it was harder for her to do so?

Lara thought things over for a moment and then said, “I’ve got an idea. Our aggregate income is $250,000, and $30,000 is 12 percent of that amount. Why don’t we each pay that percentage of our income? Under such a formula, Tara would owe $3,000, I’d owe $9,000, and Sara would owe $18,000. Since I make three times as much as Tara, I would pay three times as much. Sara, who makes twice as much as me and six times as much as Tara, would pay two times as much as me and six times as much as Tara.”

“No,” Tara said.

“No?” Lara and Sara responded in unison.

“Why not?” asked Sara. “What do you propose?”

Tara was ready with an answer: “Paying the same percentage of our incomes isn’t fair. Instead, let’s do it this way: Sara, you pay $23,450; Lara, you pay $6,550; and I will pay nothing. This is the only fair division.” Lara was surprised at how completely arbitrary this proposal was. She was also surprised at how disproportionate it was. But because her suggested share was significantly less than what she would have had to pay under her own proposal, she didn’t object.

Sara was gobsmacked. “You call that fair? I make only two times as much as Lara, but you want me to pay three-and-a-half times as much as she does? I make six times as much as you but you expect me to pay almost 80 percent of the total cost while you pay zero? Don’t forget, each family is getting exactly the same benefits from this street improvement. Where did you get such a nutty idea?” she asked Tara.

“The United States federal government,” Tara said. She pulled out a gray booklet. “It’s all right here in the IRS tax tables. Under the current tax code, here’s what each of us paid in income taxes last year:”

 

Tara’s Family

Lara’s Family

Sara’s Family

Total

Income

$25,000

$75,000

$150,000

$250,000

Taxes Paid

0

$6,550

$23,450

$30,000

Effective
tax rate

0%

8.7%

15.6%

12%


“By an amazing coincidence, our total taxes paid were exactly equal to the $30,000 we spent to improve the street. This is the progressive income tax system all US citizens live under. I don’t see why the Gini families ought to live any differently. In fact, I believe all future resource pooling should be divided in this fashion.”

“I’m in,” Lara said.

So, by a democratic vote of two to one, the cost of street improvements was divided in the following way:

 

Tara’s Family

Lara’s Family

Sara’s Family

Total

Dollars

$0

$6,550

$23,450

$30,000

Percentage

0%

21.8%

78.2%

100%


And by a vote of two to one, all future improvements were to be divided up exactly the same way.

The moral(s)

There are a number of morals in Hagopian’s parable. The parable should help to simplify and crystallize some of the trouble with taxation and redistribution from a moral point of view, as well as show just how completely arbitrary a progressive taxation system is.

But there’s more. What the parable does not immediately unpack is the incentive effects of the progressive taxation system. In other words, it’s not just that progressive taxation might be wrong ex ante — that is, an affront to the rights and liberties of Sara Gini’s family — but it might have perverse effects when we look at it through a more consequentialist lens. (We’ll save that case for another day.)

This article is excerpted from the book Superwealth.

Further Reading

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