Income, Capital and the "Buffett Rule"
Billionaire Warren Buffett is feeling under-taxed these days. He wants rates to increase substantially on people in his economic circle—you know, the owner of the local dry cleaner chain and the guys running your town’s four-truck home remodeling outfit. Democrats are reportedly obliging with the “Buffett Rule,” a plan to raise tax rates on “millionaires and billionaires” even higher than the hikes coming with next year’s expiration of the Bush-era rate reductions and the full revelation of Obamacare's glorious penumbras and emanations.
But if income above an arbitrary threshold is taxed away, how do people without capital—like Warren Buffett in his early years—ever acquire any? After-tax income, saved and invested, is the only way for most individuals to accumulate assets and have a shot at becoming actually rich, rather than rich-in-name-only (whaddaya know? a new kind of RINO).
And since actual rich people vote disproportionately liberal, you would think that the Democrats would want more of them. But that’s another matter.
Not exactly coincidentally, in his early years Mr. Buffett came up with a boffo capital formation approach, one that keeps him remarkably insulated from congressional tax rate tinkering. Initially, Buffett leveraged other people’s capital as a money manager in a deal with an unusual performance clause--outstanding performance generated outsized personal returns for the manager—and Mr. Buffett did a terrific job for his investors. He deployed the capital accumulated from this gig to go into the insurance business.
A vital attribute of insurance is that policyholders pay premiums into reserve accounts against future payouts. The resulting “float” is available for investment without incurring interest charges, and investments can be held indefinitely at the corporate level without incurring taxable gain. But these tax-free positions add to the value of the underlying company, causing the stock price to climb. At the individual level, taxes are also optional since the owner, Mr. Buffett in this case, realizes no taxable gain unless he sells underlying shares.
In between voluntary taxable events, therefore, Buffett’s net worth compounds tax-free.
So, if you are a savvy investor with a Berkshire Hathaway-like corporate structure, you don’t much care about the tax rate on capital gains or ordinary income. An enormous pile of already-accumulated capital certainly doesn’t hurt either.
Moving to the other, more numerous end of the president’s “millionaire and billionaire” category, how can you, as sole proprietor of the local dry cleaner chain, fund the purchase of new EPA-mandated equipment for your shops? The new machinery, your accountants tell you, will last a long time—at least until the next EPA-mandated upgrade—so you can’t deduct the six-figure purchase price from taxable income this year. And the IRS just siphoned off most of your free cash at the “millionaire and billionaire” rate—thanks, Warren! There’s always savings, but your account is still tapped out from the new mandatory low-flow toilets in the recently upgraded ADA-compliant bathrooms, illuminated by costly-but-dim fluorescent fixtures.
You have three choices: 1) lay some employees off and close one of your shops; 2) borrow the money. Debt is tax-free and interest is tax-deductible. Such a deal! What could possibly go wrong with this approach? 3) Go out of business entirely, exchanging entrepreneurship for a job with a paycheck. Maybe your new company will enjoy a waiver from federal taxes, like the one General Electric seems to have.
There is a fourth option to consider in parallel: dedicate yourself to catalyzing a November 2012 constitutional restoration.
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Re: Income, Capital and the "Buffett Rule"
Absolutely fascinating, George. I'd always sensed that Buffet was a great deal more conniving than his "aw-shucks, I'm-just-a-boy-from Omaha" self-presentation, but I'd never come across any real analysis.
You've nailed it.
The very rich really are different from the rest of us. They've figured out how to avoid taxes.
Re: Income, Capital and the "Buffett Rule"
Alice Schroeder details all of this in her fascinating biography, The Snowball: Warren Buffett and the Business of Life.
I find what Warren did to earn his billions in the early years entirely commendable: He worked hard to become the world's best fundamental buy-and-hold investor and created a tax-advantaged structure within which to compound his winnings. His more recent high-profile investments, such as backing Goldman Sachs during the 2008 financial meltdown, have a more statist tinge. But this may be inevitable. As Buffett himself observes, given the large size of his assets now, he can no longer pursue the sort of smaller investments that were once his bread-and-butter.
I find Buffett's recent political shenanigans in favor of the death tax--more life insurance policies to sell and distressed family businesses to buy!--and, of course, higher income tax rates, to be a good deal more problematic.
Jun '10
Re: Income, Capital and the "Buffett Rule"
You don't have to sell capital to use capital, and the more capital you have, the truer that is. Buffett is operating like the government operates. He just makes wiser investments...because it's HIS money.
May '10
Re: Income, Capital and the "Buffett Rule"
(Daydreaming of fantasy land} Perhaps Buffet could be interviewed only by reporters who understand this and who would ask to see his check to the IRS for whatever he thinks is his reasonable tax share. Time to put up or shut up.
(Oh! Who slapped me awake?}
May '10
Re: Income, Capital and the "Buffett Rule"
Snowball was a good read, as was the earlier biography by Roger Lowenstein. Buffett's M.O. is hardly hidden; Dr. Savage could also prove his point many times over just by citing the brief investor guide Buffett makes available on Berkshire's website (if memory serves, he even refers to "putting off the tax man"). Dr. Savage is right that there's no reason to hassle the man for being a first class investor and for finding an angle that the rest of us wish we would have used. However, the dissonance between Buffett's business and his insufferable, naive sermons on tax policy have long since become more than I can bear. They're even worse now that the president repeats them ad nauseum.
Interesting footnote that may or may not have anything to do with this discussion: Buffett's father, Howard Buffett, was a Republican congressman from Nebraska during the 1930s. Even by that era's standards, Howard Buffett was a strident isolationist with a Bircher-style platform.
Mar '11
Re: Income, Capital and the "Buffett Rule"
Buffet calling for higher taxes on the "rich" is like Gandhi doing those Beef Council commercials, remember "Beef, its what dinner."
Jun '10
Re: Income, Capital and the "Buffett Rule"
Statists ask productive citizens to sacrifice more and more. Buffet and regressives never ask for government to sacrifice by shrinking its expenditures. It is not the duty of Americans to support avaricious and irresponsible politicians who use our government to increase their power. There are just not enough taxes available to pay the bills. Increasing revenue only increases the appetite to spend more. No one would have ever heard of Buffet if he operated his businesses with the same frivolous attitude towards finances as our government. Cut the spending, remove the regulations, get government of the backs of American citizens and businesses. Giving government more revenue is giving drugs to a junkie. I am a simple guy and this is my simple reply.
Jun '10
Re: Income, Capital and the "Buffett Rule"
P.S.
My life has never been impeeded or harmed by a millionaire or billionaire. Our government, OTH, is an entity many citizens, including myself, are beginning to dread.
Feb '11
Re: Income, Capital and the "Buffett Rule"
If the you don't want the new Microsofts to be be in the United States, then Buffet's high taxes strategy is perfect. Buffet never invests in technological companies, which are going to be the engine of America's future, but in old companies. Buffet is a dinosaur and should be treated as such. Progressives are themselves dinosaurs, so it's a perfect fit.
Re: Income, Capital and the "Buffett Rule"
Buffett invests in stable companies that are unlikely to be disrupted. Meanwhile, the whole risky object of a typical high-tech company is to disrupt entrenched incumbents--any of you buying music CDs at a store anymore? High tax rates favor incumbents. A conglomerate structure creates a large internal market to manage profit reporting in a tax advantaged fashion. The political clout that comes from having operations everywhere is also a plus when government is calling the shots.
High tax rates mean less to worry about to those who have arrived. Your room at the resort is available at Christmas, your table at the restaurant beckons on your schedule. No upstart will upstage you. Unfortunately, economic growth stagnates and opportunity dwindles for the have nots.
Mar '11
Re: Income, Capital and the "Buffett Rule"
Given the uneven quality of current GOP front runners I fear entrepreneurs may already be resigning themselves to a fifth option, going Galt.