The Other Side of Warren Buffett’s Common Sense Tax Argument

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Warren Buffett has called for higher taxes on the wealthy, including himself.

Over the years, Warren Buffett has gotten a lot of miles out of his folksy charm and ability to distill elaborate financial concepts into plain English. And recently, proponents of higher tax rates for the wealthy have gotten a lot of miles out of those qualities too, as the world’s fourth richest man has advocated repeatedly for just that policy. This week, Buffett was at it again — this time in the New York Times Op-Ed section — calling for, among other things, a higher capital-gains tax rate.

For years, capital gains have generally been taxed at a lower rate than ordinary income, partly in order to spur investment. The idea is that if taxpayers spend their money by investing in wealth-creating enterprises, then we’ll all be better off than we’d be if they simply spent their money consuming luxury goods or expensive vacations.

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But Buffett took aim at this logic, writing:

Suppose that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”

Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1%.” Only in Grover Norquist’s imagination does such a response exist.

Basically, Buffett is arguing that investors will invest, regardless of what portion the government takes out of their profit after the fact, and that we shouldn’t worry about using the tax code to encourage investment. Instead, he suggests, we should worry that a lower capital-gains rate is unfair to those who make most of their income from labor, which is taxed at a higher rate under current law. It’s this wrinkle in the tax code, after all, that allowed Mitt Romney to pay such low effective tax rates in 2010 and 2011.

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So who is right? Economists on the left, like Jared Bernstein, former chief economic adviser to Vice President Joe Biden, argue that the evidence shows that higher capital-gains tax rates do not lead to less investment. In a blog post last summer, Bernstein cited several studies that show that changes in the capital-gains rate had negligible effects on investment. He wrote:

There are a few economic principles that we consistently get wrong in ways that do lasting damage to our economy and diminish our future. At the top of this list are arguments about large behavioral responses to changes in tax rates. I don’t think it’s zero, but I’ve simply never seen compelling evidence that tax increases significantly hurt growth, labor supply, jobs, wages, or that rate decreases provide much of a boost the other way.

Conservatives tend to respond that the reason it’s difficult to demonstrate empirically the negative effects of higher capital-gains taxes is that economies are huge, complex beasts full of moving parts. The dramatic economic growth of the Internet boom, for instance, may have drowned out the disincentives of higher capital-gains taxes when President Clinton briefly raised them in the 1990s — but that doesn’t mean that negative effects didn’t exist.

Another conservative line of argument is that capital-gains taxes raise the cost of capital for companies. Firms get equity capital from the stock market by issuing shares. If dividends and capital gains on those shares are taxed at a higher rate, then the value of those shares to investors will decrease and as a result, corporations won’t be able to raise as much money and will have less money to build factories and hire employees.

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Finally, conservatives say that capital-gains and dividend taxes are examples of “double taxation.” When a firm whose stock you own pays a dividend, that dividend came out of corporate earnings that have already been taxed. And when you sell a stock and realize a gain, it’s quite possible that you bought that stock with money that was already taxed as labor income. If you’re a moderately wealthy wage earner already paying a high income tax rate who faces the prospect of paying that same high rate on investment returns, you may not leave your money in a bank account (as Buffett’s scenario lampoons), but it’s not hard to imagine your deciding to spend that money on luxury goods instead. Why get taxed twice?

Of course, this example of moderately well-off wage earners doesn’t represent the majority of investors. Many investors are, like Mitt Romney, already wealthy and simply reinvesting investment income that was taxed at a lower rate. And many more are invested in the stock market through 401(k) plans, which are funded with pretax wages.

Nobody likes taxes. They’re are a necessary evil — the only way we can fund government. But given the state of the middle class in this country, it would seem that higher taxes on capital gains, which hit mostly the rich, are one of the more palatable ways we can raise the revenue we need to bring the budget deficit under control. So while Buffett does oversimplify the case for increasing capital-gains taxes, the essence of his argument stands up to scrutiny. If we raise capital-gains taxes just a bit or even change the code so that they match the rates of ordinary income, there will still be investors ready to take advantage of winning investment ideas.

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30 comments
Dachman
Dachman

So lets say we raise taxes on the rich to 45% and the economy does not turn around, what do we do next? Do we ever cut spending? I know cut defence spending, what happens if the economy does not turn around? What do you cut next?

This is all a very real and likely scenario...

SixSixSix
SixSixSix

Heard to know if this article is satire or not. First if the effect is immeasurable then scientifically it is a peak on BS mountain. Second to be really rich to to be unable spend more than you reasonable want. You have already taken all you need by whatever personal standard you set, and refuse to leave the rest so it becomes all about ego building numbers. You simply can't buy enough toys or get sick enough to really use up your money. You have to let it out for power and status from the satisfaction of simply making it bigger. Whether driven by need or more likely the ego trip from big numbers the rich will not stop. The rich wanting to get richer is very inelastic and thus a great target to tax without much fear of distortion.

jaltman636
jaltman636

No one points out the obvious errors in the reasoning.  Capital Gains tax involves no double taxation.  The tax is only on the profit from the investment.  The purchase price, or "basis" is subtracted from the sale price to calculate the gain.  How many more errors are used to pretend that lower taxes on the rich somehow benefit the rest of us. 

Tax rates on the rich and the unemployment rate are exactly counter-cyclical.  John Maynard Keynes was right and the contrary theories are all promulgated by rich folk seeking only to get richer.

SixSixSix
SixSixSix

@jaltman636 Not only the "basis" is subtracted  so are any other costs incurred making the sale that lead to the capital gain, meaning it is levied on net revenue. I would argue that "double taxation" is only meaningful to owner operated companies. Otherwise you are riding along on a group activity and it is fair game to tax the group (corporation) as an entity. Corporations are fictitious legal entities enjoying liability protection for its owners and management while incurring tax liability. For those who truly do not want double taxation this country has unusually rich alternates including sole proprietorships (with liability) plus Chapter-S corporations and single member (with liability) for true own operators. Canadians would love the have either one of the latter two.

superlogi
superlogi

Taxes are a necessary evil.  That being the case, they should be utilized sparingly, effectively and efficiently and only for things society needs, not for what society wants.

Nelle
Nelle

Check out MarkPashCfp below.

kc1tom
kc1tom

I'm middle-class taxpayer. If I buy & hold property for 40 years, it generates little Fed tax until it's sold. If I sell it, and it gets resold every 5 years, it generates much more tax over the years. I'm more inclined to make the investment AND sell if I have a lower tax rate. When the capital tax rate was equal to normal income tax bracket, very few commercial properties were on the market. That being said, it appears to me that a cap for capital gains solves both situations: capital gains at 15-20% up to $500,000 (arbitrary), then 27-30%.  That allows small businesses to function and invest, yet taxes those with nearly all capital gains income to pay a higher rate. 

superlogi
superlogi

@kc1tom The problem with your analysis is, that investment income always produces employment.  Always.  And any tax on invested income, even at it's lowest level will reduce that investment and re-channel it into government consumption.  One could also argue that all corporate taxation (C corps), is nothing more than an inefficient user fee passed along to consumers which should also be abolished.  Yes, we do need a source of revenues but the simpler the collection process, the better.  But, the bottom lines is that we use both taxes and borrowed money for things we want, most of which we don't need.  Frankly, I'm in favor of all taxes being collected on all personal income with a poverty limit and absolutely no deductions.  With regard to progressivity, that would be negotiable.  Oh, and since payroll taxes are ridiculously inadequate to fund entitlements, one might as well call a spade a spade and abolish those as well.  The bottom line is, we should be able to get by on 20% of GDP (Federal Spending) which means we need to come up with about $3 trillion in revenue.  The only question is, depending on one's income, what share should they pay?  Will it ever happen? No, simply because it would reduce political power and restore personal power.

PeterPonomaroff
PeterPonomaroff

A very real way government can help in the economic recovery is to help ease uncertainty. If people believe that the government will change the rules on their investment, whether that investment is starting a business, buying a home, investing in property, securities, or whatever, that adds risk. Our political parties need to get their act together and do whatever it is they are going to do (and it doesn't matter what that is) and then act in a way that assures people that the rules will remain the same for a decent period of time. Then the government needs to get out of the way and let our economic system work. The reason the US has been an economic powerhouse is that the system can adjust and overcome the idiots who believe they control it.

mikekibler
mikekibler

when reviewing numerous commentaries, blogs, etc on applicable tax rate on dividends/capital gains, i have not seen anyone address the value   "risk".  when a person receives compensation for work, they are guaranteed payment.  i have found when a person invests in their own business, nothing is guaranteed except hard work, long hours and even in success, a lot of grief. why should their capital gains be taxed the same as ordinary income where a person invests nothing except their time on the job?  

Nelle
Nelle

@mikekibler So one person's blood, sweat and tears counts more than another's?  The hours of your life are more valuable than the hours of another's?  A worker couldn't possible contribute to a business' success? 

Many wage earning, lower income people find themselves with 401(k) retirement plans, since they are cheaper for business persons to offer.  When that worker retires they will find their income from this investment plan is taxed as earned income.  All of it, including any growth from the investments.  Pray God there may be some with all those risk taking, super wise business people and bankers running the economy. 

dawiemea
dawiemea

It is O.K. for Buffett to propose higher capital gains tax if he himself is not affected at all. If he really want the super rich to pay tax, put a charge on the capital gains in trusts like his, which will never ever be capital gains.  And with the prolonged low interest rates there are millions who live from the capital gains, albeit in small amounts. Why tax them if is is the authorities fault in the first place why they cannot live on the interest.

antonmarq
antonmarq

As a supporter of higher tax, I find the whole idea of 15% capital gain tax ridiculous, it should be taxed at income. I also feel that mostly all tax loops, (except some special circumstances), should be eliminated. However, I also feel that this country needs some serious and committed leaders (note, plural) that have the wisdom and vision to create a great nation, again. 

Unlike many, I see taxes, (or any revenue types), as the prime source of investment that ensures America's security needs, whether people or country, during periods of normality or stress are available. What good are jobs, capital gains, investments,  or any other individual 's wealth building strategy, if the country they rely on is in shambles?

Our infrastructure is an early 20th Century joke. Our education system is eroded my by a cash-and-carry approach where money, not education drives grades. Our police forces is weak and over-exerted. Our transportation system are still using pre- WWII designs and systems to operate, which are mostly inefficient and obsolete. And, the American people themselves are quickly becoming walking blobs of aimless meanderers, just waiting to be put to the barbecue.  It's no wonder the world disrespects this country, we are becoming the joke of humanity.

Our proud industries give away their hard earned R&D to foreign countries. Our politicians are bought by businesses that are controlled by individual or foreign powers to support their isolated causes. Our government laws have been skewed to protect the few, while dis-enfranchising the many. The list is endless.

Welcome to the new America. A place where aimless babble dominate the media. A place where greed driven individualism propagates without conscience or concerns about exposing our behinds to the world. A place, unlike Rome or Greece, where the separatist find shelter in promoting ignorance until the storm hits and swallows everyone.

It's not about taxes people, it's about America.  

Nelle
Nelle

@antonmarq I may not agree on every point, but I certainly share many of your frustrations.  It should be about all of America first, which means paying for it, each according to their means.  

SamuelYap
SamuelYap

I think the problem is not only whether or not investments will be made because of higher capital gains tax, or a higher income tax rate for the 1%. I think the argument is more about fairness, justice and equality. Why should a State tax the middle class and the poor more on their income, and less on the rich and corporations who can afford to do so? From an equity and fairness standpoint, it just isn't fair why the less privileged should be taxed more than the privileged.

JamesMcMurtry
JamesMcMurtry

The author misses a key point. Buffet doesn't want to raise taxes on all capital gains - only on marginal income over 1 million.

BurntToast
BurntToast like.author.displayName 1 Like

The problem is not that people will stop investing, its that after increased taxes they will have less post tax money to invest.

milton.recht
milton.recht like.author.displayName 1 Like

What Warren Buffet ignores is the growth effect over time on the economy of reinvesting proceeds from one investment into the next under higher and lower capital gains tax rates. If one makes a capital investment, let's say in a start up, makes a gain and sells for a capital gain after one year and then reinvest the proceeds into a new successful start-up for another one year gain, sells, reinvest the proceeds again and follows this investment scenario going forward, the total private investment each year is bigger under a lower capital gains tax. Each year, in a 15 percent capital gains tax, the private sector start-ups will have had more gains invested in them than under a 35 percent tax scenario. The private sector economy will be much bigger, generating more sales revenue, profit, taxes and employment than under the higher capital gains tax. Sure you might still make each investment under a high and low tax rate, but with a lower capital gains tax, there is more private money to invest each year in businesses. More investment yields more successful businesses, more jobs, more income, more wealth and more tax revenue w/o raising the capital gains rate. After 20 years, starting with the same funds, due to compounding, the private sector will have about 45 percent more in total invested in it and be bigger under a lower capital gains tax than a higher capital gains tax. A zero capital gains tax scenario would have about 75 percent more invested in private business than under a 35 percent gain capital tax rate, if the proceeds were reinvested.

The question is not whether an investor will invest. The question is how much will the investor invest. With lower capital gains tax rates, there is more private money to invest and over time the initial investments grow and the positive effects on the economy become more important.

williamshaver
williamshaver

In the history of where we are today, the success of the 1990's and the economic collapse in the circumstances other than government actions created the success of the 1990's and the collapse.  Prior to Ronald Reagan,  oil supply and the spending of the Johnson Administration created rapidly increasing inflation.  To control inflation, price controls were tried, and interest rates were rapidly increased.  After President Reagan went into office, interest rates began rapidly decreases.  The Fed action played a much greater role than did the tax decrease.  Two men played a pivotal role in the 1990's success. These two men were Bill Gates and Steve Jobs.  Bill Gates offered new software innovations that offered much greater efficiency.  Competition among computer brands rapidly pushed down the price of computers, making them affordable to small companies.  Steve Jobs in the early years made a good computer.  Steve Jobs early contribution was getting computers into the school systems.  Whenever one gives good technology to young people, they take the ball and run with it.  By the time the 1990's came, the internet was coming into play, the .com companies, etc.  While the technology companies were creating new jobs, many jobs were disappearing because of improved efficiency.  After George W. Bush went into office, some of these .com companies were discovering a company cannot exist but so long without making money.  These companies paid no taxes because they made no money.  The government did not create the collapse during the Bush Administration.  It was the pay and bonus system without adequate oversight.  The collapse occurred after a tax rate decrease.  The tax code is in need of a massive overhaul, but not all at once.  Investment in stocks, etc. should be for long term capital appreciation, not dividends.  Credits, exemptions, deductions should be gradually reduced to a set maximum over a ten year period of time.  I read in a magazine, I believe it was Forbes, something to the effect, "The only thing worse than paying taxes, is not having to pay taxes. 

CindySchultz
CindySchultz like.author.displayName 1 Like

While Warren Buffett thinks that everyone else should pay higher Capital Gains taxes, he uses a loophole to pay none.  Not that anybody has noticed but Mr. Buffett, who is now giving much of his money away before he dies, doesn't donate 1 dime in actual cash to his and his childrens' foundations.  He donates his Berkshire Hathaway stock.  And he does it to avoid paying Capital Gains taxes on any of it.  Here's how it works.  As of last August, Buffett gave over $2 billion in stock to his family's foundations and most likely took a tax deduction for his donation.  After the stock was in the names of Buffett's foundations, the stock was sold totally exempt from paying any Capital Gains tax.  Then, the foundations dished out money to causes dear to the Buffett family.  Unfortunately, many of these causes are not even in the United States.  For instance, one of Buffett's foundations gave over $3,000,000.00 to help with reproductive health in India.  The list of contributions to foreign charities goes on and on.  Before Mr. Buffett can preach about how everyone else should hand their money over to the feds to blow, he needs to put his money where his mouth is and at least pay something.    

Johnjcpa@yahoo.com
Johnjcpa@yahoo.com like.author.displayName 1 Like

@CindySchultz

As opposed to Romney's giving appreciated stock to his Church through a trust that allows him to continue to receive income from the "gifts". And how is trying to do something about the wretched conditions in third world countries less worthy than building temples. I'm going out on a limb here, and guess you're a Christian.

Aje
Aje like.author.displayName like.author.displayName like.author.displayName 3 Like

@CindySchultz What kind of twisted logic is this? Seriously. You are criticizing the man for giving his money to charities? Really? REALLY?

MarkPashCfp
MarkPashCfp like.author.displayName like.author.displayName 2 Like

We know for sure Capital Gains taxes do not hurt growth but the key is total revenue collected.  Investors tend to implement the tax strategies to reduce capital gains taxes and slow sales so the total revenue collected is higher at certain lower percentages.  We just raised them for big earners in Obamacare by 3.8%!  Also, the lower the capital gain rate helps the States with capital gains taxes because they are somewhat ignored.  What is the answer?  The answer is to have a completely separate Capital Gains calculation page within the tax return.  This means it is not integrated in the calculation  of the other taxes and make it very progressive.  Start it at 5-10% for the first $5000 to $10000 in gains.  This very low starting rate will generate extremely high revenue as the Stock and other liquid markets will have more taxable transactions to take advantage of this low rate at the end of the year.  Then start moving up the scale at various income levels to the maximum bracket.  If you eliminate 1031 real estate exchanges and a few other fancy tax shelters at the upper levels, taxpayers will have no choice but to pay the taxes.  But, if they are to high, people won't sell!

There is almost no reasons not tax interest and dividends at the same rates as wages including payroll taxes!

The best tax incentive for the economy is to lower the employee paid FICA tax a couple of percent and eliminate the cap.  This will permanently put more money in people earning about &120,000 or less.  One should always include Payroll Tax as part of any income tax discussion!!

Center for Progressive Economics

www.cpe.us.com

Johnjcpa@yahoo.com
Johnjcpa@yahoo.com

@MarkPashCfp

More effective would be to move away from funding social security from direct wage tax and move to a VAT across all goods and services. This would remove the added cost of FICA on US produced goods by spreading FICA onto imports.

Nelle
Nelle

@Johnjcpa@yahoo.com  Funding Social Security through payroll deductions is a convenient and fair (progressive) way to pay for it.  It is a 'tax' in the same way that the mandate to buy insurance under Obamacare is a tax (as decided by the Supreme Court.)  Both require the beneficiaries to pay for the plan, and both spread the risks over the larger population receiving the benefits.  They are both insurance plans, not entitlements or give aways.

I wish that everyone, politicians, media people, citizens, would stop calling Social Security an 'entitlement,' a loaded, coded word.  It is a plan designed to pay for itself, quite efficiently run, and massively successful so far in spite of the efforts of many politicians who can't keep their fingers out of the till.  It has been so successful that it is not broke even now.  Adjusting the amount of money paid into the plan is all it would take to keep it that way.  Any politician who tells you otherwise has an ideological axe to grind.  Be sure and keep your head out from under it.  

JohnYuEsq
JohnYuEsq like.author.displayName 1 Like

Rome is burning! Stop squabbling and get going! RAISE taxes on the WELL TO DO, and leave the rest of US ALONE!