Monday, August 15, 2011

Warren Buffett on Taxes

Today Warren Buffett published an article on taxes.

He starts with his own example:
Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

He continues by refusing the notion that higher taxes make people invest less or even differently:
Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.
I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain.

He closes by telling his reader that the super-rich are mostly quite willing to pay higher taxes:
I know well many of the mega-rich and, by and large, they are very decent people. They love America and appreciate the opportunity this country has given them. Many have joined the Giving Pledge, promising to give most of their wealth to philanthropy. Most wouldn’t mind being told to pay more in taxes as well, particularly when so many of their fellow citizens are truly suffering.

If that were an MMORPG, people would comment that nobody keeps him from giving money to the government if he wants to. Just like nobody keeps you from walking instead of teleporting, from looking for a group instead of using LFD or from refusing epics if you want them to be rare to you. Luckily real life is still a bit more serious than MMORPGs (not much).

On taxing capital gains: many people argue that capital gains should not be taxed or that it's good that they are taxed at 15% in the US, because the money has already been taxed before. Mr. Buffett disagrees, and so do I. While the money one invests has already been taxed, the capital gains, the interest or dividend one gains, has not been taxed. And it should be taxed like any other income, because that's exactly what it is.
Investors work hard to find out where to invest the money. In return they earn capital gains. Other people work hard to repair bridges. In return they earn income. There are differences, but none that justify a different tax rate.

On taxes and jobs: an investor is constantly on the lookout for good opportunities. He invests in the best opportunities he can find. If all these opportunities look X% less profitable, this doesn't change his behavior. Keep X reasonable, please. Of course 100% or 99% might change his behavior, but if X = 0%, 15% or X = 50% this really doesn't change his behavior.
And this is true for almost all income taxes. Only very few people would work less if you tax them more. In fact, some people would work more, because they had to, to keep their standard of living. Most taxpayers, especially wealthy people, don't work for money in the first place. They work for prestige and to prevent boredom. They use the money they earn to compare themselves to others, just like everybody else. If everybody pays the same tax rate, the results of this comparison remain unchanged.


  1. Differences are in the risk of actual return. Capital gains are extremely fickle and one year or another, you might actually have negative delta. A dividend can be a lot less secure, although that would vary from company to company. Earned income, salaried income, and employment benefits are guaranteed, in so much that when they are issued, at minimum, you get exactly that.

    My friends aren't super-rich, but they do have different mixes of the above types depending on the risk they're willing to take to put food on the table. As an example, some of them hold stock in the company they work for (awarded via stock options) that are underwater now. At the time, it seemed beneficial to hold for the capital gain.

  2. An interesting point, dataferret.

    1) past loss can/could be taken into account when calculating taxes.

    2) some taxpayers might think that you are ironic, calling their earned income "guaranteed".

  3. Actually, the way I see recommended most frequently about dividend double taxation is to have dividends be a deductible business expense. But that is not politically viable these days.

    a Company sells $10,000 and earns profits of $1000 this year. At the end of the year they will pay, say 300 in taxes leaving 700 in after tax earnings. If they had a dividend-payout ratio of 40% that would say they would pay their shareholders $280 dollars. With taxable dividends, the government takes another 30% or so of the $280 given to the shareholders as part of the original $10,000 sales.

    This is more problematic as the corporation has complete control over how they spend the $280. E.g., the company could use the money to buy out other companies. Or your favorite: Blizzard share repurchase. So if Blizzard repurchases shares, then the value of my stock increases, but I don't owe any taxes until I sell it, which could be years from now. When dividends were taxable, I preferred companies that more focused on growing stock value not dividends. But after the tech bubble, the argument was that actual cash dividends were preferable since they were more concrete and less subject to financial manipulation the way pro-forma earnings are.

  4. Very interesting post, just one comment:

    "If all these opportunities look X% less profitable, this doesn't change his behavior."

    What if some of the opportunities are in a different country that has a different value for X?

  5. Good argument, Hagu. One more reason to not tax corporations. But the left is too stupid to understand that taxing businesses doesn't make sense, unfortunately.

    So, even though your point is valid, I don't think it is important enough to justify strong regressive taxes. Not from a justice - point of view, not from a economic-PoV and certainly not from a political-stability-PoV.

    @ Me:
    This is the one really good argument for low taxes on the rich, in my opinion. Two things follow:

    1) Competition between countries is not always good. It can turn into a race to the bottom, and often does. We need mutual global agreements here. Actually, we have several.

    2) Don't overestimate the willingness of rich people to move to another country. If somebody earns 4 mio a year after taxes and you start to take one more mio away from him every year, he may scream and shout.

    Just like WoW players scream and shout when you nerf their class. But he won't move. Rich people, more than anybody else, understand that money alone doesn't make you happy.

  6. 1) Loss offset rules for capital gains do help, but on a horizon scale that's less than 10 years, I would take no comfort that for instance my portfolio is currently standing at -30%.

    Beyond ten years, the historical performance favors at least some positive value, even with such high volatility. But we only reach parity with other forms of income if said persons can withstand the draw-downs. It is why there even exists a bond-market at all - as a lot of investors cannot risk it.

    2) With regards to anything being 'guaranteed', earned income - in the eyes of most civic laws - is usually the most secured form of income. Even during bankruptcies, you stand in line before creditors. Now whether there's anything left to be paid at all, is another question, but once you've done the work you are guaranteed that compensation. Your employment standing may differ.

  7. @Nils

    1) I obviously need to do my homework next time - I didn't know about the international agreements. But I would imagine that, given the number of politicians involved, and the diffiulty of getting politicians to agree on anything, those agreements tend to the lower end of the scale.

    2) Again, I'm not too clued up about tax law, but does the person actually have to emigrate? If they live in one country and invest money in another, where do they pay tax?

  8. But the rich don't really have to move, they can afford to just change their residence for tax purposes. I am familiar with UK software entrepreneurs who spent 6 months in Holland prior to the sale to avoid some taxes. (N.B. US is fundamentally different in that they try to get world-wide income.)

    And in your Buffett example, he is worth $50 billion dollars. His net worth probably fluctuates more day-to-day than what the taxing authorities consider his annual income. I.e., taking 0% or 100% of his "income" is not that significant to his wealth or well-being. For constitutional reasons, municipal bond income can't be taxed by the federal government: Ross Perot had a few billion dollars of them with interest taxed at 0%. How progressive is a 70% tax rate for super-rich that they don't pay due to legal tax avoidance (residences, tax shelters, trusts?)
    In the short term, there is not an exodus when there is a price or tax increase. But in the longer term, there are price-demand curves.

    I do know that the number of US dividend-oriented mutual funds & ETFs significantly increased when individuals dividend income taxation was reduced.

    While a small %, I do know that many thousands of people left California (13% state income tax versus 0% for Nevada, Texas, et al) A founder of an acquired software company who had not yet sold his stock told us employees "The state of California is paying me $500,000 to move to Austin."