Tuesday, October 30, 2007

Stick to Investing, Not Tax Policy: Mr. Buffett's Latest Tax-Raising Efforts

This morning’s news programs featured Warren Buffett and his latest political posturing in favor of higher taxes. It seems Warren polled his office staff, and all but two responded. (Are those two now on guard duty outside his Omaha home?) The poll question: what is your average tax rate for payroll and income taxes combined.

Mr. Buffett has volunteered his personal rate: 17.2 percent. The rate for all of his staff: higher than 17.2 percent. Thus, he concludes, Congress should do something to rectify the disparity.

Of course, one way to remedy the disparity would be to cut rates for someone. But that is, of course, not the result he desires. He apparently wants parity between the Forbes 400 members like him and the office staff, which in this case means raising taxes on the “rich”.

I have always found it amusing when Mr. Buffett talks about taxes. Though he is a great investor, it seems as though he never read an economics book. He has apparently read populist political literature, though. Moreover, in this TV appearance, to add punch to his message, he pointed out that he did not use tax planning, he just did what Congress allows. Sure, no planning when it comes to money. That is believable – not!

But even if we believe the Oracle on that point, the comparison in his little “poll” is just plain misleading. First, he wants to raise federal income taxes. So we should compare income taxes, not income and social security and medicare taxes combined. Keep in mind, social security taxes are capped at $97,500 per year of earned income. I would guess that with his salary and directors fees, Warren is above the limit. This means that his share – 6.2 percent – adds up to $6045. If you spread that tax out over millions of dollars of taxable income, the average tax rate drops well below the 6.2 percent imposed on the employee with more modest earnings, i.e., below the social security cap. At $1 million, the rate is less than 1 percent; at $10 million, less than .1 percent. Thus, this tax is small.

But is it appropriate to measure the tax in proportion to income? In this case, no. Despite his vast wealth, Mr. Buffett will get the identical benefits from the social security system as the comrade who earns only the capped amount of $97,500. Thus, this tax is really a forced exaction for a social benefit. Should the rich pay more for the same benefits? Not unless you want to increase the redistributional aspects of this system. But of course, that is not how social security is sold to the public - it is not supposed to be welfare, but a safety net paid for by taxes on earned income to replace that earned income on retirement.

As I explained to my students, I drive a 10 year old car. My property taxes on that car are small. A student may buy a new car, perhaps borrowing the funds to purchase it, but since the car is new, the property taxes there will be high. On the basis of income (despite my very modest income level), my average tax rate from such property taxes will be decidedly lower than that of the student with the new car, who earns little but has a big property tax bill on that sweet ride. But if you complained about the difference, there would be little outrage, or at least I would hope so. We are focusing on different things here.

Now, let’s go back to the income tax issue. Is Mr. Buffett suggesting that the income tax system is not sufficiently progressive? If so, he has not consulted the latest figures from the IRS. The Statistics of income figures show that, in fact, the top 1 percent of taxpayers have an average tax rate of 23.13 percent, versus 12.45 percent average for all taxpayers. (You can access this information at the IRS website.) That is because, unlike Mr. Buffett, many high-income taxpayers have a high proportion of earned income. They are physicians, business owners and managers, entertainers, lawyers (though relatively few of us), and other hard-working Americans. They are, indeed, paying more – much more, than other Americans.

Here, Mr. Buffett may be raising another concern: there is a preferential tax rate on dividends. Since he reports such a low average tax rate of 17.2 percent – I would guess much lower than Oprah or Tiger Woods, for example – most of his income must be from dividends (or capital gains, if he sold some investments), which under the Bush administration’s initiatives in 2003, are taxed at only 15 percent. But there is a reason for this as well. The companies from which he received those dividends had to pay them with after-tax dollars. And thus, his capital that generated the income had already been taxed at the corporate level. Of course, Mr. Buffett is not taking this into account when he says the rate is too low. But it is disingenuous not to do so.

Though Mr. Buffett may wish to raise taxes on capital, the impact of such taxes on investors -- and ultimately for the many employees who work for them -- is not favorable. The U.S. already enjoys corporate tax rates that are above that of most other developed countries. Companies pay them because, after all, there are great opportunities in this country. But as other countries offer more opportunities, we need to pay attention lest our competitive position be eroded. Moreover, it should also be remembered that other investors – with more ordinary levels of capital – may need to accumulate more to achieve life goals, like saving for a home, for the education of children, and for retirement security. Every new tax on investment potentially affects these people, too.

The disappointing thing about Mr. Buffett’s latest media ploy is that he knows better. But he still chooses the sensational over the sensible. That is out of character for this super-investor, but not-so-super tax policy wonk.


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