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tax matters

The nice thing about an election year that's accompanied by federal budget surpluses is that it's fertile ground for tax cuts – and both the Conservatives and Liberals have promised that tax savings are on the way. But who should really benefit from tax cuts? While it might not seem politically correct to suggest that the rich should get the lion's share of tax breaks, let me share a story that I first shared many years ago that provides food for thought here.

The cost of dinner

Each and every day, 10 men go to a restaurant for dinner together. The bill for all 10 comes to $100 each day. If the bill were paid the way we pay our taxes, the first four would pay nothing; the fifth would pay $1; the sixth would pay $3; the seventh $7; the eighth $12; the ninth $18. The 10th man – the richest – would pay $59. Although the 10 men didn't share the bill equally, they all seemed content enough with the arrangement – until the restaurant owner threw them a curve.

"You're all very good customers," the owner said, "so I'm going to reduce the cost of your daily meal by $20. I'm going to charge you just $80 in total." The 10 men looked at each other and seemed genuinely surprised, but quite happy about the news.

The first four men, of course, are unaffected because they weren't paying anything for their meals anyway. They'll still eat for free. The big question is how to divvy up the $20 in savings among the remaining six in a way that's fair for each of them. They realized that $20 divided by six is $3.33, but if they subtract that amount from each person's share, then the fifth and sixth men would end up being paid to eat their meals. The restaurant owner suggested that it would be fair to reduce each person's bill by roughly the same percentage, and he proceeded to work out the amounts that each should pay.

The results? The fifth man paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $14, leaving the 10th man with a bill of $50 instead of $59. Outside the restaurant, the men began to compare their savings. "I only got one dollar out of the $20," said the sixth man, pointing to the 10th man, "and he got $9!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too! It's not fair that he got nine times more than me!" "That's true," shouted the seventh man. "Why should he get back $9 when I only got $2? The rich 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 outraged men surrounded the 10th and brutally assaulted him. The next day, he didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they faced a problem that they hadn't faced before. They were $50 short.

The moral

There are a couple of lessons to be learned here. The first is an observation from my wife: If the 10 individuals had been women, they probably would have figured things out. But in all seriousness, I'm going to suggest that the approach taken by the restaurant owner in the story is exactly the right approach to divvying up tax cuts. It's how our system should work. The people who pay the highest taxes should get the greatest relief from a tax cut, in absolute dollars.

The fact is, if you overtax the rich, they just might not show up for dinner next time. After all, there are plenty of good restaurants around the world.

This story is relevant today because both the Conservatives and the Liberals have proposed to cut taxes – in different ways. The Liberals have said that they would offer no tax cuts to the rich, but would instead increase the tax burden on the highest earners. The problem with this, of course, is that pushing any taxpayer's marginal tax rate to 50 per cent or higher (which would be the case for many Canadians, particularly in provinces that also have taken steps to increase the marginal tax rate for the highest earners) will absolutely cause those folks to explore new ways to bring the tax burden down. And in the end, it may drive some to leave.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.

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