Thursday, July 28, 2011

Why Warren Buffett is a Failure at Tax Policy

Warren Buffett is talking tax policy again. His commentary is an accumulation of errors, confusion, egalitarianism and interventionist policy recommendations.

He is again bemoaning the supposed fact that the rich pay a lower tax rate than the secretaries of the rich, but instead of calling for lower taxes for secretaries (Don't they need the money?), he is calling for higher taxes on the rich. Go figure.

One problem with his "the secretaries are paying higher taxes" is that this does not apply versus those simply earning high incomes. They are already paying at the highest tax rate, as the chart below shows. Lower tax rates do often apply for banksters and crony capitalists who get various tax breaks, but, again, instead of calling for more tax breaks for secretaries, he wants the income of the rich taxed even more, with one exception.  He wants tax breaks for corporate jets to continue. (The fact that he owns a corporate jet leasing business through Berkshire Hathaway is surely a coincidence).

Here's Steve Moore in Thursday's WSJ on what's really going on at the tax level for those with high incomes:
The Oracle of Omaha is at it again. On July 7, Warren Buffett told Bloomberg: "I think the rich have a responsibility to pay higher tax rates." Then he groused that his wealthy friends are "paying lower tax rates than the people who are serving us the food." Mr. Buffett has been voicing this complaint for years, once observing that his personal tax rate of 17.7% is lower than that of his receptionist (30%).

During Monday night's national address, President Obama recited the Buffet line that millionaires and billionaires pay lower tax rates than their secretaries. Democrats in Congress routinely cite Mr. Buffett's tax confessions as irrefutable evidence that tax rates on the very rich are too low and the system is unfair. And the system would be unfair, if Mr. Buffett's tax facts were the whole truth. But they aren't.

I don't know the details of Warren Buffet's personal taxes, and he hasn't made them public. But the IRS does provide reliable data on effective tax rates—the overall share of their income that various groups pay in federal income taxes (not including state or local taxes) after accounting for all deductions and exemptions. These are different than marginal tax rates, which are paid on the next dollar of income and now peak at 35% for individuals.

IRS data for 2008, for example, show that households in the top 10% of earners (above about $114,000) paid 19% of their income to the feds (see chart above). Those in the top 1% (above $380,000) paid 23.3%. The top 0.1% of earners, with incomes of $2 million or more, end up paying a slightly lower tax of 22.7%, because they get more of their income from investments (more about this below).

So what about the rest of us? According to IRS data, a median-income household ($35,000) in 2008 paid about 4% of its income in federal income tax.
So we already have a very progressive income tax system, despite Buffett's suggestion that the situation is otherwise. This may satisfy many who buy into President Obama's mantra that the "rich should pitch in their fair share."---and they may want even more of a progressive tax system.  But  there is a great danger with  progressive taxation. Ludwig von Mises explains:
The philosophy underlying the system of progressive taxation is that the income and the wealth of the well-to-do classes can be freely tapped. What the advocates of these tax rates fail to realize is that the greater part of the income taxes away would not have been consumed but saved and invested. In fact, this fiscal policy does not only prevent the further accumulation of new capital. It brings about capital decumulation.
Bottom line: There is a danger in taxing the rich, that Buffett and the President fail to acknowledge. The rich are the ones who provide the funds to build the base of capital goods that make an economy productive. Every increase in taxes "on the rich"  results in a cut in this production.

In the old days, Buffett used to readily admit that he was not skilled in forecasting the direction of the overall economy and that he, therefore, stayed away from doing so. Now, however, he apparently considers himself  an expert on tax policy, but he fails to understand a key factor.

He is good at understanding money flows, and that's about it. That's what made him a great investor. But, he has no imagination and readily admits that he stays away from technology companies. He comes out of the Benjamin Graham school of equity analysis, which is about studying cash flows (and balance sheets).

When he is calling for higher taxes on the rich, he is simply putting his cash flow analysis to government revenues and expenses. But, he is failing to look beyond how the government taxation impacts the overall economy, something he admits he is not good at. If he looked beyond the simple cash flows, he would understand that money flowing into the government bureaucracy results in operations like the floundering Post Office, the Department of Education, the National Interagency Fire Center.
 and corporate cronyism gone wild. At the same time, money that stays in the private sector funds such marvels as Apple, Google and, yes, Berkshire Hathaway's own operations. Buffett considers none of this. How could he? He tells us he can not accurately view the future of technology companies. But. also, he fails to dig in and look at the belly of the bureaucracy. Could Buffett honestly call for higher taxes on anyone, if he really took the time to study inside the belly of the bureaucratic beast, where new tax money would flow? I suggest he would vomit.

It's a combination of Buffett going over to the dark side, especially once he started competing with Donald Rumsfeld  for the affections of the ultimate insider Kay Graham (and then he got the oligarch's edge on that Goldman Sachs deal), and a skill set that ends abruptly at cash flow analysis that has turned Buffett into one of the worst tax policy advisers going, probably right up there with Paul Krugman and Robert Reich---and they don't even use cash flow analysis to get to the same absurd tax policy views that he holds.

(Chart via Mark Perry)


  1. Buffet is probably one of the most calculating businessmen in America that has a long history of taking care of his own interests first. While we will never know his real intentions behind his dishonest tax debate (I know, because I pay at a rate higher then him and his secretary), my guess is that most of his taxable income is capital gains in nature which means the most he'll ever pay is about 5pts more then he would today. I have to beleive he knows he is putting forth a dishonest argument since the man is on top of just about everything he does or says.

    Here is what I think is his reason. Buffet has had a long time hatred of private equity and hedge funds which he competes with for deal flow. PE especially looks for the same types of cash/asset rich companies as does buffet. Without a doubt taxes are a part of the calculation in determining whether a deal is worth the investment or not. One of the things that he hates (he has said this many times) is that they pay taxes at the same rate he does with the special capital gains treatment they get on their carried interest.

    He also knows that there is no way to close this loophole without burring it in an across the board tax crusade on the rich. I think congress has been trying to end this carried interest thing since the Bush years with no success and even Obama care didn’t change this with all democrats in control. You can bet that this will be part of a broader tax increase across the board. So a PE or Hedge fund could see taxes on a large part of their income go from 15% to well over 40% since most often these funds are setup as flow through entities, this would effectively hand Buffets hated competitors a 300% tax increase, while BRK/Buffet would only see a 25% increase.

  2. Buffet has made himself wealthy in the capitalist-ish US system, but he fails to understand exactly what Mises is quoted as saying in WSJ.

    But, in our corrupt, fraudulent system, our rulers think capital savings is not important because we have the FED to print up fresh new FRNs for the big banks to invest, and the USG to spend into circulation.

  3. 1. Re taxes. The US is one of the most HEAVILY taxed places in the world, if you take into account the ones in addition to payroll/income taxes - sales taxes, import duties, estate taxes, road tolls, taxation of non-citizens and non-residents, gift taxes, property taxes, and business taxes. On some airline flights, the cost of the ticket is DOUBLED by the taxes alone.

    Yes, there are loop holes and deductions - but again, these things are ALSO burdens - on our time and labor. How many weeks of labor is it to read up on all the tax changes, gather documentation, save receipts, calculate, and file endless forms?

    What about the burden of penalties, and wrong calculations, and miscalculation...and the stress...?

    And the invasion of privacy involved in government IDs...and the identity crimes resulting from the misuse of SS#s?

    2. Off-topic.

    Right-wing domestic terrorists come under fire:

  4. "IRS data for 2008, for example, show that households in the top 10% of earners (above about $114,000) paid 19% of their income to the feds"

    That is not correct.

    The table is showing federal income tax, not the total incidence of federal taxes. The income tax is heavily progressive but payroll taxes, at least if you identify incidence with how much payroll tax is collected on each worker, are regressive, so that the total federal tax burden is much flatter as a function of income than the federal income tax.

    We don't really know what the incidence of federal (or other) taxation is, because one cannot safely assume that the person who hands over the money is the one whose consumption is reduced as a result. The tax might (for example) reduce the supply of labor and raise wages, transferring some of the cost to consumers.