In my previous post, I accused Warren Buffet of hypocrisy. Now I’ll state my case.
In the 2003 article, Buffett claims that if the then proposed dividend tax reductions were passed, his tax rate would drop to 3%. Making this claim ignores the taxes Berkshire Hathaway paid on Buffett’s behalf as an owner of the corporation. Further, I can assure you that Buffett does not ignore taxes paid by a company when evaluating how much he is willing to spend to buy a company.
Buffett explains it well in his own letter to shareholders in Berkshire Hathaway’s annual reports (which I highly recommend reading for anyone remotely interested in business and investment management).
For those that don’t know, Berkshire Hathaway is Buffett’s business. B-H is a holding company that owns many other businesses, such as Dairy Queen and GEICO insurance, outright. It also owns substantial positions in other publicly traded companies like Coca-Cola. For example, B-H owns 8.6% of Coca-Cola’s outstanding shares amounting to $11.4 billion in value as of last December.
Each year in his letter to shareholders, Buffett explains how he views such holdings. On page 90 of the latest annual report, Buffett writes
Accounting consequences do not influence our operating or capital-allocation decisions.
He goes onto to explain that one accounting consequence is what gets reported as income from the companies that that Berkshire Hathaway partially owns, like Coca-Cola. Accounting principles require B-H to report dividends Coco-Cola pays them. But, he also views earnings retained by the companies as if they were his own because he believes this represents the true economic value the company produced for B-H and its owners. I agree with him on this point.
For example, Buffett views B-H’s 8.6% ownership share of Coke’s undistributed earnings as Berkshire Hathaway’s earnings. He calls these look-through earnings. As an owner of a company, the true economic value a company creates for you is the sum of the earnings it distributes and retains.
Pretend you own an ice cream shop. If you are good and lucky, at the end of each month the shop has cash left over after paying the shop’s bills. This surplus is the shop’s earnings.
You may take some of the earnings to pay your living expenses and then you decide to keep the remaining cash in the business. You might decide to keep these earnings in a bank account as a cushion for the slower winter months or use the undistributed funds to open another location, buy a competitor or buy a freezer to hold more ice cream cakes.
Buffett’s look-through earnings is the total of the earnings you take out of the business for your living expenses and the funds you keep in the business. I agree with this view because it represents your true wealth and the true economic value generated by the ice cream shop.
Yet, Buffett ignores his idea of look-through earnings when it comes to his tax policy positions. In his 2003 article in the Washington Post (available under the fold on this post) . Buffett wrote:
Now the Senate says that dividends should be tax-free to recipients. Suppose this measure goes through and the directors of Berkshire Hathaway (which does not now pay a dividend) therefore decide to pay $1 billion in dividends next year. Owning 31 percent of Berkshire, I would receive $310 million in additional income, owe not another dime in federal tax, and see my tax rate plunge to 3 percent.
And our receptionist? She’d still be paying about 30 percent, which means she would be contributing about 10 times the proportion of her income that I would to such government pursuits as fighting terrorism, waging wars and supporting the elderly. Let me repeat the point: Her overall federal tax rate would be 10 times what my rate would be.
To draw this conclusion, Buffett ignores the income taxes paid by Berkshire Hathaway on his behalf. Whether BH pays a dividend of $1 billion dividend or not is irrelevant. That’s an accounting consequence. Buffett, owning 31 percent (at the time) of the BH, owns 31% of the $1 billion whether it is paid as a dividend or retained by the company.
In 2003 BH paid a tax rate of 30% on those $1 billion in earnings. That means BH paid a little over $100 million in corporate income tax on Buffett’s behalf (the math: $1 billion of earnings x 31% ownership of Buffett x 30% corporate tax rate).
Whether the $1 billion is reported as income on Buffett’s or BH’s tax return is merely an accounting consequence. It doesn’t change the fact that Buffett owned 31% of BH and BH paid 30% in corporate income tax on its earnings.
Again, Buffett doesn’t ignore taxes paid by a company when evaluating what he is willing to spend to buy it. He only ignores these taxes when trying to make an invalid and political point about tax policy.
I’d love to know if I’m missing something. Based on what I know of Buffett, I don’t think he would intentionally deceive. He may have good rationale for the inconsistency in his views and I’d love to understand that if he does. But, based on what I know, he appears to be making an error.