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.

  • David

    Jeff, I’m a regular reader and like the blog.  But you say above: “What is a tax after all? It’s what we voluntarily pay the government.”  Where exactly do you get the “voluntary” part here? I do not pay taxes voluntarily.  It’s forced out of my hands.

    • Well, you could not pay them. Then they sick the IRS after you and you go to jail or pay a fine. In European countries, so many people avoid the tax that they just can’t enforce it.

      There is a level of taxation where you would pay and not care. Correct me if I am wrong, but if the government wasn’t the way it was (wasteful, slothful, inefficient et al) you’d pay taxes and feel okay.

      • David

        “Well, you could not pay them. Then they sick the IRS after you and you go to jail or pay a fine.”

        Exactly.   You make my point.

        “There is a level of taxation where you would pay and not care. Correct me if I am wrong, but if the government wasn’t the way it was (wasteful, slothful, inefficient et al) you’d pay taxes and feel okay.”

        I’d probably pay a voluntary sum (1%, 2% of my income?) for the running of the government.  But that’s different from the coerced taxes I pay today.

        • David

          (Same David as above.)

          “There is a level of taxation where you would pay and not care. Correct me if I am wrong, but if the government wasn’t the way it was (wasteful, slothful, inefficient et al) you’d pay taxes and feel okay.”

          If the government were 100% efficient with my taxes I would still object to taxation.  Taxation is still coercion regardless of how wasteful or unwasteful the government may be.  The fact is no other man has any right to my wealth. 

          You said in your post that we should get “philosophical” about taxes.  If you’re going to do that you need to start talking about what it means to be a man, man’s rights and what a social system looks like if it is to protect those rights. 

          • Agree. We need some sort of government structure to run the country. Even the founders recognized that. Let’s strip it down to its most basic. We need a rule of law (judiciary), the ability to enforce that law (police), defend ourselves (military), and protect ourselves and provide basic necessities for living (things like firemen, fresh water).

            As we organize ourselves from pioneers to city and suburban dwellers, we outsource a lot of the last item; basic necessities. So we pay for garbage pick up because it’s more efficient, have street lights etc. Let’s assume you are correct and 1-2% would cover basic needs etc, the extra part of your tax bill goes to the part where we become city dwellers and make society more efficient. You will pay for that efficiency-but as you and I agree-that aspect of federal, state, and muni govt has become way too big.

          • David

            I don’t see why there should not be a completely free market (i.e not just outsourced) in areas typically called “basic necessities” such as water supply, sewage, electricity, roads, lamposts, garbage etc.  (Not sure about firemen.)  The more advanced a society the greater the imperative for free markets (indeed the advancement was caused by free markets). I think we would see an explosion in our standards of living if businessmen who provide these basic necessities were free from government regulation.  

            Digressing a little bit, I think the biggest issue today is not entitlements, but regulation.  We need to throw off all of this regulation and allow businessmen to produce again. This will create so much abundance that it will make the rolling back of entitlements easier to deal with.

          • I may philosophically agree with you, but then there is the politics of reality too.  No one is going to go for a free market in drinking water today (although futures on crop and industrial water are a good idea).  

            If we tackle bull crap regulatory agencies and cabinet positions first, and handle entitlements in a close second, we will significantly reduce the size and scope of govt. 

          • David

            For sure none of this is going to happen soon. But you’ve got to have a vision of where you want to be and then take concrete, realistic short term steps to get there.  Btw came across this today, which you might enjoy: http://www.thestreet.com/video/11254095/what-would-ayn-rand-do.html#1170718787001

          • haven’t watched your vid yet, but apparently, the Buffett tax doesn’t affect Buffett….

          • David

            For a guy who likes people to like him, not a great proposal 😛

          • David

            Santelli thinks we should abolish a ton of regulations too: http://www.realclearpolitics.com/video/2011/09/22/rick_santelli_to_obama_do_something.html

          • He’s right!

  • Berniecongress

    This is not about raising revenue to mesh Govt at 26% of Gnp  vs taxes at 15% of GNP
    its not about efficiency or common sense,
    its about class warfare, crony capitalism,  foodstamps for votes, and fight over POWER and 
    chance to steal the treasury and distribute it to your interest group;
        if they dont win, then bankrupt the government…thats the plan.  

    • agree that it’s class warfare and the rest. They ought to end deductions for everything (no winners or losers then), and cut the marginal rate down to at least 15% for everyone, regardless of income. No not paying taxes either.

  • Roberams

    I keep wondering when this blog will have any worthwhile trading discussions instead of the endless political axe grinding. I don’t know why I keep checking. I think you should just become a full-time Tea Party hack and give up the “Wise Trader” bit.

    • Jeff Carter

      Thanks for the advice. Do you have a blog? Right now, there happens to be an intersection of finance and politics everywhere all the time or did you miss the bit this morning about Barney Frank wanting to abolish the Federal Reserve system as we know it and just staff voting members of the FOMC with political appointees?

      Has been that way since August of 2007 when Hank Paulsen bailed out his buddies on Wall Street for the first time.

    • When Washington stops meddling in the market place.  Virtually all they have done since August of 2007 is stick their fingers in and messed it up more than it was.  Plus, the fiscal policy of the country since 2008 has been atrocious.  But, we might fix it in 2012.

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