The Warren Buffett Tax
In a widely read NYT editorial, famous investor Warren Buffett has proposed tax increases for the rich, like himself. Although one of the richest men in the world, Mr. Buffett claims that he pays a lower tax rate than the secretaries in his office. That seems really strange. The data put forth by Warren are as follows: in 2010 he paid total tax of $6 million, which constituted a 17% average tax rate on his taxable income. Warren argues that most of the people in his office, including some secretaries, have a higher tax burden than this.
Applying the magic of arithmetic, that implies that Buffett’s taxable income in 2010 was about $35.3 million. But what form did this income take? His primary asset is his approximate 25% stake in Berkshire Hathaway where he is the Chairman of the Board. His salary at Berkshire has been $100,000 for many years. In 2010, Berkshire had after-tax income of $12.9 billion. This means that the book value of Buffett’s investment rose by $3.2 billion. But this “income” is not taxable to him (however, the company did pay $5.6 billion in corporate taxes, Warren’s share of this was $1.4 billion). Berkshire does not pay a dividend. Further, it appears that Warren did not sell any shares in Berkshire. Therefore, his entire taxable income from Berkshire was the salary of $100,000 and the value of miscellaneous benefits that came to about $450,000.
So, where did the $35 million of taxable income come from? Warren did not specify exactly, but it is likely that he holds ownership stakes in investments aside from BRK/A. For example, suppose he holds a bond portfolio that is equally divided between corporate bonds (tax rate 35%) municipal bonds (tax rate 0%), this would generate interest income with an average tax rate of about 17%. Or, perhaps he sold some securities with total capital gains of $35 million, most of which were long-term gains (tax rate 15%) and a little of which were short-term gains (tax rate 35%). Again, the average rate would be around 17%. Finally, and I suspect most likely, Warren holds a substantial portfolio of stocks aside from Berkshire. If this portfolio had a market value of $1.75 trillion and a dividend yield of 2%, it would generate $35 million of dividend income, with tax rate 15%.
In any of these possibilities, the bulk of his income is capital income not wage income. Some have interpreted Warren’s proposal as eliminating the Bush tax cuts that lowered the top income tax rate from 39.6% to 35%. Actually, Warren appears to be proposing to create a higher tax bracket on people, like him, that have taxable income greater than $1 million, and a yet higher bracket on those with taxable income greater than $10 million. Most of such income is income on capital. If you raise taxes on capital, the likely outcomes include lesser capital formation and slower long-term economic growth. It would have little effect on the Buffett fortune, but it would deter future fortunes from being created.
If you really wanted to attack the Buffett fortune, then a tax on wealth would be the ticket. How about an X% tax on all net worth above a floor level? Warren appears to want to target the top .3% of the wealth distribution. Well, the best estimates are that the top .1% of the wealth distribution includes people with net worth greater than $20 million, and these folks cumulatively have about $9 trillion, or about 15% of total household wealth. If we were able to collect 20% on all net worth above a threshold of $20 million, then in theory we would collect approximately $1.4 trillion of additional tax revenue (the tax base would be $7 Trillion = $9 trillion less the $20 million threshold for each household; the revenue would be this tax base times 20%). This would largely wipe out the current federal deficit! In future years, of course, the revenues would be lower as the cumulative wealth of the richest folks would decline.
This 20% wealth tax would be highly original (and catchy too, we could call it the “20 on 20” plan), but there are some problems with the concept. Putting aside the moral aspect of confiscating wealth, is it feasible to expect to collect this tax? Currently, the primary wealth tax is the property tax that is generally in the range 1-2%. And this is on property that is not movable. If a 20% tax were imposed on assets that are transferable (out of the country, or into non-taxable foundations) then it would likely be the case that the tax base in fact would turn out to be well below the expected $7 trillion.
Even if this wealth tax could be effectively implemented, would it be a good way to go? Warren’s editorial has inspired a lot of comment. One theme is that if rich people want to increase their tax contribution, then they are free to do so. Warren has chosen to give the bulk of his estate to the Bill and Melinda Gates Foundation. Apparently, he feels that they will put the funds to better use than would the U.S. government.
Warren Buffet. Stop Coddling the Super-Rich. The New York Times, August 14, 2011.