Mr. Buffett, His Secretary, and Financial Literacy

I’ve long admired Warren Buffett and still do. I’ve heard him tell many times how his secretary pays a larger percentage of her small income on taxes than he pays on his large income. Sometimes he elaborates; sometimes he doesn’t. When he doesn’t, he does a great disservice to the cause of financial literacy in this country and, inadvertently, I’m sure, stokes the embers of class resentment. This is not a good time to be doing that.

I was traveling and didn’t see his August 15 New York Times opinion piece on that topic, but I saw and heard lots of references to it. I don’t think any of them got to the heart of the matter. Instead, it was, as usual, all about the unfairness of rich people paying a smaller share than poor people. I’m sure that fed and enflamed the preconceptions of lots of well-meaning, but uninformed voters, whose emotions are already running ahead of the facts.

I tracked down the piece to see if it was as bad as its superficial coverage suggested. It wasn’t, but you wouldn’t know that from the title, Stop Coddling the Super-Rich. The highlighted phrase was “Billionaires like me should pay more taxes.” I’m sure most taxpayers would agree with that, including those who don’t actually pay any federal income taxes because their incomes are below the taxable threshold.

The point—the heart of the matter—is that most of Mr. Buffett’s income consists of dividends and long-term capital gains that are currently taxed at a 15 percent rate. This is true of many money managers whose “carried interest” is taxed at that favorable rate. Somehow that doesn’t seem fair. But the picture clouds once you consider that this is not the first time that income is taxed. The corporation was first taxed on it, possibly at the high marginal rate of 35 percent, the same as the highest earned-income marginal rate on individuals. Thirty-five plus 15 add up to a 50 percent total. Thirty-five plus another 35, which Mr. Buffett presumably would suggest would add up to a 70 percent total—a pretty hefty tax on capital.

Mr. Buffet did not demagogue in his piece as one would assume based on its reporting. He gave a fair analysis of the issues involved. My experience tells me that he probably didn’t choose the title put on his piece by the editors. But I’m guessing serious damage was done by the title and the short-hand, slip-shod coverage of his piece in the popular press.

Frankly, I don’t have a firm position on the issue of carried interest or the taxation of professional investors. It still seems unfair even when you recognize the logic of it. The lead editorial in the Wall Street Journal had a good analysis of various aspects of the issue on August 17, which, as one would expect, is just a predictable as the New York Times position.

Perhaps they should leave the favorable treatment as it is up to a point, but then have some minimum tax that must be paid if gross income is above some level. They might call it an “alternative minimum tax.”  But, wait! I think we tried that already, and it didn’t work out so well.

Comments (5)

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  1. Andrew Hwang says:

    Your article, like many that are critical of Buffett’s, share a common fallacy that capital gains and dividends as earned and distributed by corporations are being unfairly double taxed. They are not. and this article may inadvertently contribute to financial mis-literacy.

    Suppose, as a highly compensated professional I get paid a salary (a capital allocation choice employed by my employer for my productivity), I would be expected pay at the full marginal tax rate beyond a certain threshold. Now if I go to a lawyer for his services on a personal matter and pay him with after-tax money that I earned from my employer, the laywer’s income from me would also be taxed as ordinary income. Would anyone care to argue that since the capital that was employed through me had already been taxed once, that the lawyer should be paying a lower tax rate, 15% instead of the 33% that I paid earlier? Would you argue that the lawyer’s actual tax rate on the capital he reined from me, had he paid the same rate that I did, is unfairly high, at 33%+33%=66%? That is what you have suggested in your article.
    Now imagine instead of paying the lawyer, I use the same money to pay/invest in a hedge fund manager who hopefully employs it to some productive ends and earns a return and charges me a fee, shouldn’t he be taxed the same way as the lawyer or myself? Why should he receive a favorable tax rate? The fairness of taxation rules is what Buffett is trying to get to.

    The laws of this land specify that corporations are independent entities with certain rights and certain obligations, much like individuals. The tax is based on each individual’s receipt of the capital, whether it came from someone’s labor or a corporation’s deployment on some productive activity. If an individual laments that the money invested through a corporation gets taxed at the corporate level and again as a dividend and wishes no tax on the dividend, the corporation and the individual would be considered the same entity and the individual should not expect the benefits of limited liability through investing in the corporation. Milton Friedman says there is no free lunch, but people still try to get one whenever they can.

    It is time the tax system is made more equitable. A very small segment of the population is getting very rich off the backs of middle-high income earners. And to people that consider tax as stealing, I would argue they are stealing from me and all the people in my community/country every time they drive on the road we have built and drank the clean water we have purified for safe consumption with our tax dollars.

  2. The consumption oriented “Fair Tax” is the way to go. People should be taxed on what they consume, not on what they earn.

    Abolishing the federal income tax (and reinforcing that with a Constitutional Amendment, as we have here in Texas), would render this entire discussion moot and turn this debate away from the issue of how much people earn to what they spend their earnings on.

    By this measure, Warren Buffett would still retain a lower tax rate, but not because his income is generated in the form of dividends and capital gains. Rather, he would maintain a low tax rate, because he lives rather modestly and reinvests most of his earnings, rather than spending them on current day luxury items. Reinvesting large sums of capital is the source of economic growth, and the federal tax code should encourage that, rather than discouraging it, as liberal policies like the income tax do.

    The Fair Tax is also more cost efficient to collect, which would help reduce the Federal budget deficit. The typical Home Depot cash register, for example, probably receives 10+ times as much income each yearas the average US family, in the form of sales. So, moving the point of taxation away from the individual & family and onto the cash registers and other points of sale would reduce the number of tax forms and audits each year, thereby reducing the “cost of collection” at the federal government.

    Furthermore, a tax on business sales, rather than families and individuals, is more consistent with the important American political principles of personal privacy and individual property rights. No longer would the IRS have the right to delve into individual & family finances, interfere with family financial relationships, or break into the individual’s home for tax collection purposes. Instead, the IRS would interact with businesses, making the process of tax collection more of a professional interaction between trained personnel in the government and in business, rather than a deeply personal interaction between the government and individual families. In short, the abolition of the personal and family income tax reinforces the important and very American notion of the “sanctity of the home and family.”

    Last, but certainly not least, by shifting the focus on taxation from income to sales, people would be incentivized to save and invest more, while consuming less. Increased, tax-free savings and investment, in lieu of debt-fueled consumption, would help people to get ahead faster, by building up savings. There is also an ancillary stimulative effect on the economy, when large numbers of individuals accumulate savings and investment, because those funds go into more stimulative, job creating growth activities when they are invested, rather than being spent.

    As a frugal billionaire, Warren Buffett would continue to benefit from a low tax rate, under the http://www.fairtax.org. Other billionaires, who spend more lavishly, would be forced to pay higher taxes on their lavish consumption spending, which seems to be the purpose of Warren Buffet’s public relations campaign on this issue. After all, if he simply wanted to pay more taxes, himself, then he is free to write checks to the US Treasury above and beyond the amounts that he owes under the current tax system.

    Jonathan L. Gal
    Rockwall, TX

  3. tobyw says:

    Buffett neglects to mention the big tax break that his office staff receives. Their benefit package is not taxed, and may be as large as their W2 wages in a big company like BH. If compensation including employers share of FICA is the same size as wages, this cuts their tax as a share of total compensation in half which makes it about 17%, the same as Buffett’s.

    Not to mention double taxation of Buffett’s income before it leaves the company.

    -T

  4. BillA says:

    @Hwang;
    This would be true if it weren’t for the fact that, as a stock holder, you own part of the company. So when the company pays taxes, you in effect have paid taxes as well, and when you get your dividend check you would pay the lower rate, due to the fact that it is the Second time it is being taxed.

  5. Veli says:

    The USA’s AAA rating is like a suedemorpl who’s become a crack whore wearing her 100 year old Miss World tee shirt and vouge magazine putting her on the cover.When questioned about this on bloomberg the spokesman goes to the bath room to get high on the left over drugs and starts saying lets print new miss world tee shirts and just lop off a zero on the date, no one will no we’ll just not change the design too much.