Warren Buffett IS wrong on taxes

I agree with Stephen Moore’s Op piece in today’s Wall Street Journal.  I hope I may have helped inspire it.

I wrote about a stark inconsistency in the way Buffett values businesses owned by Berkshire Hathaway, the successful holding company he runs, and how he views the taxes paid by these companies here.   In my opinion, the inconsistency is so stark that he deserves the title of hypocrite.

Stephen Moore makes the same point by including the taxes paid on Buffett’s behalf by the company he owns a great deal of, Berkshire Hathaway, something Buffett does not do.

Perhaps I inspired Moore’s view on this.  I wrote to Stephen Moore shortly after Buffett’s 2003 Washington Post article (the text from that email appears below the fold).

Moore writes:

So how does Mr. Buffett arrive at such a low personal tax rate? He may have been referring to a 2010 IRS study of the 400 richest American taxpayers, a list he’s probably on. It showed those people paid an effective federal income tax of 18.1% in 2008.

Yet that study crucially omits the corporate income tax, which is mostly borne by the owners of companies.

Mr. Buffett owns about one-quarter of his investment company Berkshire Hathaway, and his shares are worth about $38 billion. This wealth is mostly stored in what are technically called “unrealized capital gains.” Eventually when those gains are converted into income, he will pay a capital gains tax. Even so, in 2008 Berkshire paid $3 billion in corporate taxes. And since Mr. Buffett is the principal owner, he shoulders a big share of that tax.

Moore goes further to point out that Buffett is wrong on the rates too, higher income folks paid a rate nearly twice as high as middle class families.

According to the Congressional Budget Office (CBO), middle-class families in 2007 (earning between $34,000 and $50,000) paid an effective 14.3% of their income in all federal taxes. The top 5% of income earners paid 27.9% and the top 1% paid 29.5%. And what about the highest earners? Americans with annual incomes above $2 million paid an average 32% of their income in federal taxes in 2005 (the most recent year for which data are available).

Moore also points out that Buffett has been a critic of one aspect of Obama’s tax proposals.

To his credit, Mr. Buffett has criticized President Obama’s near-obsessive calls for higher taxes on corporate jets.  As Mr. Buffet correctly noted, the writeoffs companies take for capital expenditures such as jets are legitimate business expenses.

Buffett’s view here is not surprising.  Berkshire Hathaway owns NetJets, a major provider of corporate jet services.  Hmmm…

One of Warren Buffett’s cardinal investing rules is to not invest in things he doesn’t know much about.  This is understandable.  He has learned through experience that this can be costly.  Apparently, it’s not nearly as costly for him to talk about things he doesn’t know much about.

My 2003 email to Stephen Moore appears below:

Mr. Moore,

I enjoyed reading your piece about “liberal do-gooders” that was reprinted in the Other Comments section of Forbes magazine from the Washington Times.  I especially like your criticism of Warren Buffett.

As a fan of Buffett’s unconventional business prowess, I was more than a little disappointed by his piece on the dividend tax cut (“Dividend Voodoo,” May, 20, 2003) in the Washington Post.

In that piece, Mr. Buffett explained that if dividends were tax-free to recipients and if he were to change Berkshire Hathaway’s dividend policy his tax rate would “plunge to 3% of his income.”  He says that this “seems a bit light” considering his receptionist would still be paying 30%.

Each year, in his Letter to Shareholders in Berkshire Hathaway’s Annual Report, Mr. Buffett states that he does not let “accounting consequences influence operating or capital allocation decisions.”  Furthermore, Mr. Buffett describes that he views Berkshire’s portion of earnings from companies in which Berkshire owns a partial stake but cannot officially report on its financial statements due to accounting rules as “look-through earnings.”  He regards look-through earnings as the true economic benefit these partial stakes provide Berkshire Hathaway’s owners because the true economic benefit is not fully reported on Berkshire’s GAAP income statement.

Unfortunately, Mr. Buffett violated his own principles in his dividend tax analysis.  First, he considers accounting consequences in his position on the dividend tax by narrowly focusing only on income he reports on his 1040.  The fact that Mr. Buffett does not report his 31% share of Berkshire Hathaway income is merely an accounting consequence, while the income and the benefits it provides Mr. Buffett is very real.  Otherwise, Mr. Buffett would not be one of the world’s richest people.

Second, Mr. Buffett ignores his standard “look-through earnings” approach to measuring value. The IRS does not require owners of corporations to report corporate earnings on their personal tax filings.  But, as Mr. Buffett eloquently explains in his writings, owners benefit directly from those earnings.

In 2002, Berkshire Hathaway paid 33% of its more than $6 billion of operating earnings in taxes.  Mr. Buffet’s share of Berkshire’s tax bill came to $659 million.  Applying the “look-through earnings” principle to his personal income, Mr. Buffett would find that his true tax bill is exactly the same in both of his scenarios and still roughly the same tax rate that his receptionist pays.  If Mr. Buffett still believes that his share would be a bit light, based on his own principles, perhaps he should feel the same way under the old dividend tax policy.

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