Once there was a little island country. The land of this country was the
tiny island itself. The total money in circulation was 2 dollars as there
were only two pieces of 1 dollar coins circulating around.

1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.

2) B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.

* The net asset of the country now = 3 dollars.

3) Now C thought that since there is only one piece of land in the country,
and land is non producible asset, its value must definitely go up. So, he
borrowed 1 dollar from A, and together with his own 1 dollar, he bought the
land from B for 2 dollars.

*A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
* Thus, the net asset of the country = 4 dollars.

4) A saw that the land he once owned has risen in value. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C.
As a result, A now owned a piece of land that is worth 3 dollars. But since
he owed B 2 dollars, his net asset is 1 dollar.

* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.
* The net asset of the country = 5 dollars. A bubble is building up.

(5) B saw that the value of land kept rising. He also wanted to own the
land. So he bought the land from A for 4 dollars. The payment is by
borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.

* As a result, A has got his debt cleared and he got the 2 coins. His net
asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt
of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.

* The net asset of the country = 6 dollars; even though, the country has
only one piece of land and 2 Dollars in circulation.

(6) Everybody has made money and everybody felt happy and prosperous.

(7) One day an evil wind blew, and an evil thought came to C's mind. "Hey,
what if the land price stop going up, how could B repay my loan. There is
only 2 dollars in circulation, and, I think after all the land that B owns
is worth at most only 1 dollar, and no more."

(8) A also thought the same way.

(9) Nobody wanted to buy land anymore.

* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars
is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net
asset is still 2 dollars, his Heart is palpitating.
* The net asset of the country = 3 dollars again.

(10) So, who has stolen the 3 dollars from the country ? Of course, before
the bubble burst B thought his land was worth 4 dollars. Actually, right
before the collapse, the net asset of the country was 6 dollars on paper.
B's net asset is still 2 dollars, his heart is palpitating.

(11) B had no choice but to declare bankruptcy. C as to relinquish his 2
dollars bad debt to B, but in return he acquired the land which is worth 1
dollar now.

* A owns the 2 coins, his net asset is 2 dollars.
* B is bankrupt, his net asset is 0 dollar. ( he lost everything )
* C got no choice but end up with a land worth only 1 dollar

* The net asset of the country = 3 dollars.

************ **End of the story; BUT ************ ********* ******

There is however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.
A few points worth noting -

(1) When a bubble is building up, the debt of individuals to one another in
a country is also building up.
(2) This story of the island is a closed system whereby there is no other
country and hence no foreign debt. The worth of the asset can only be
calculated using the island's own currency. Hence, there is no net loss.
(3) An over-damped system is assumed when the bubble burst, meaning the
land's value did not go down to below 1 dollar.
(4) When the bubble burst, the fellow with cash is the winner. The fellows
having the land or extending loan to others are the losers. The asset could
shrink or in worst case, they go bankrupt.
(5) If there is another citizen D either holding a dollar or another piece
of land but refrains from taking part in the game, he will neither win nor
lose. But he will see the value of his money or land go up and down like a
see saw.
(6) When the bubble was in the growing phase, everybody made money.
(7) If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A ) and take part in the game. But you must know when you should change everything back to cash.
(8) As in the case of land, the above phenomenon applies to stocks as well.
(9) The actual worth of land or stocks depend largely on psychology.

care to quote or give the ORIGINAL author credit?Text

how about some commentary?
something to add value?

While I agree that it would be difficult to simplify it any further, this is still probably too complicated for the average american to understand. Ever wonder why so many Americans are so focused on the size of their tax refund and yet don't know what their tax liability is?

Good read though.

Would be cool to expand into a computer simulation adding more people (Employers, Employees), a Federal Reserve System, a Treasury, and a foreign goverment.

calvinandhobbes said:i think it's a great starter for kids to start to understand asset valuation and currency (and perhaps risk), i think the "moral of the story" (those holding cash win) can be very misleading when you throw in monetary policy. If the leaders of the island started printing extra dollars, the value of the land would go up as the value of the currency went down, and those holding debt would benefit while those holding cash would not, which is a very different outcome.Let's say they print more money and distribute it evenly: 1 coin each for the 3 occupants, in a simple democratic manner. This changes the end result from

* A owns the 2 coins, his net asset is 2 dollars.
* B is bankrupt, his net asset is 0 dollar. ( he lost everything )
* C got no choice but end up with a land worth only 1 dollar

to

* A 3 dollars
* B 1 dollar
* C land (worth at least 1 dollar) and 1 dollar.

It doesn't change the ranking but it shrinks the relative wealth gap between the rich and poor. That is why inflation is an ultimate equalizer of wealth in the absence of "crony capitalism".

ETA: however this is only for domestic inflation. If inflation is only limited to imported goods, such as oil, then its effect is very different.

^^^Well, did you set him straight?

DavidScubadiver said:I just spoke with a fairly educated man who wanted to be careful about bumping up to the next tax bracket as he was convinced he would wind up losing money. We talked and he told me there are so many people who refuse to work overtime because they are afraid of getting penalized by moving up in tax brackets. This is something which I believe reflects the complexity of our tax system as much as it reflects people being generally unaware of finance....I meet so many people who believe this, my ex-girlfriend was one of them. Maybe her lack of a grasp on finance was why it didn't work out.

nycll said:scripta said:^^^ there are certain cut-offs in taxes that are not gradually phased in. One would have to make a significant amount of money just to cover the benefits available under that cut-off level. For example, being below the poverty level (amount depends on the number of dependents) qualifies the entire family for additional social services, medical coverage, food stamps, utility discounts, and subsidized federal student loans. Go over by $1 and you lose a lot more than $1.

Most other things are gradual, but cost vs benefit is not a straight line. If your first job puts you in the 35% tax bracket (fed+state) but under OASDI (6.2% = social security) limit ($97.5K in 2007, $102K in 2008 I think) for example, and you do some 1099 consulting on the side, you'll end up paying 50.3% in taxes (35% + 15.3% self employment) on any 1099 profit above your salary and below OASDI. But if your first job puts you over the OASDI limit, you'll pay a lot less (either 44.1% or 37.9%, depending on whether self-employment tax is subject to OASDI limit, I don't know). That's the most significant example of cost vs benefit I can think of, but I'm sure as you make more money it becomes more costly to work a second job in the higher income tax brackets. You're not going to lose anything at these levels, you just won't make as much for the same amount of work.Somehow I don't think Dave's friend is a welfare recepient. So by working overtime he will make less out of every overtime dollar he makes, becuase of the progressiveness of the code. But he will not end up losing money.That is correct, he is not on welfare. Makes a decent living and owns a beautiful home. I did set him straight. It mostly related to his spouse taking on an extra job. I assured him that financially they will not be losing more than they are gaining as a result of her possibly putting them over into the next higher tax bracket. (I also told him to go to IRS.gov and ensure the withholdings were being properly made so there was no nasty surprises).

My understanding is the AMT is always there. When we say it kicks in, it just means the AMT tax liability is higher than ordinary tax liability.

EX1: Social Security is a fixed percentage of income with no bracket structure. So there's no need for you to get any of that back because you fairly paid that percentage on the amount you made that month.

The income tax deduction, as you point out, was higher than it should have been because your employer's software guessed you'd make that much every month and be in a higher tax bracket for the whole YEAR. If in fact you are not in the higher tax bracket for the year, then they withheld too much that one month, and you'll get it refunded.