Buffett and Taxes

Much is being made of Warren Buffett and the Obama “Buffett Tax” proposal. Buffett said he pays his taxes at a lower marginal rate than his secretary. Roughly half. His secretary supposedly pays 33%, and Warren pays close to 18%.

That means that Mr. Buffett’s secretary makes at least $174,400, and no more than $379,150. I don’t want to get bogged down in all that and if I were Buffett’s secretary I suppose I would rather be paid in stock like Ray Kroc did for his. the secretary would be money ahead, and when they sold it they’d pay long term capital gains of 15%.

I think though now is a good time to have a philosophical debate about capital and taxes.

What is a tax after all? It’s what we voluntarily pay the government. If a majority of us simply stopped paying taxes, or avoided most of them like they do in Europe, our government would go broke faster. But, Americans assume they have a legal contract with the government to “provide for the general welfare”, so most of us don’t mind paying some taxes. Truth be told, 47% of Americans paid no income tax last year except what was deducted from their paycheck. Many of them got that back when they filed a tax return. From the citizens perspective, a tax is an amount of income they are willing to part with to keep a civilized society.

On the other hand, what is government’s perspective on taxes? REVENUE. Plain and simple. It’s as folksy as I can put it since we are talking about a Buffett tax.
The government needs revenue to operate. Without it, it goes bankrupt and defaults.

Economically, no matter what, the nature of the firm or the nature of government is to try and expand. In the private sector a firm has incentive to expand because of profits. The governments incentive to expand isn’t based on profit at all. It’s based on power. The more it can expand, the more power it has. The more power government has, the less freedom individuals have. Government always will want more revenue.

There are better ways to give the government what it wants, more revenue, and give the people what they want, more freedom and less tax burden.

Unfortunately we have followed an economic path of trying to stimulate demand. Stimulating demand is stupid. It’s a money loser. Instead, what you have to do is let private industry create supply. Then demand will be created to access that supply.

Let me give you and example. Suppose an individual owns a small business. They file taxes at the individual rate, because it’s cheaper for them to operate their business as an individual rather than incorporate and file as a corporation. Today assume that the business files returns at 35%, same as the corporate rate.

What would the business do if the government eliminated all deductions and dropped the marginal rate to 15%?

What would happen to revenue? Changing the marginal rate will change the supply line for the small business. This will have an effect on demand, theoretically increasing it.

If you say that the company will pay less in taxes, you are incorrect. They will pay less in taxes based on their past performance. Even if you redid the accounting to reflect the changes, the company would still pay less. But, they were making business decisions based on the old tax law, not the new one. Change the tax laws you change the internal cost/benefit decisions that companies make. If they expand enough, they will wind up paying more dollars in taxes than they did previously, even though they do it at a lower rate. The key is they will be keeping more of their total income.

By lowering the marginal tax rate, companies will have incentive to expand. When they expand, they become more productive. More production equals higher revenues, and will more than make up for the drop in marginal rates.

At the same time that we lower rates, we need to trim the size of government. In the short run, the government will receive some windfall profits from lower marginal rates and from the economic boomlet that follows. However, that cannot go on forever.

The size and scope of government must be cut at the same time that marginal rates are cut. That means more freedom for the constituents, and returns government to its rightful place as simply a background manager of a civil society-not a behemoth that tries to force society where it wants society to go.

Raising rates is a disincentive to invest. Lowering rates is incentive to expand. It’s as simple as that.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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