Extra Credit Assignment

If I were an econ or math professor I might be inclined to assign an extra credit for a short explanation of Buffett’s tax rate comparison to his secretary’s.

Nobody seems to be able to get this much ballyhooed comparison — and inspiration for Obama’s “Buffett Rule” — correct.

Here’s what my answer to the assignment would look like:

The above table shows a comparison between the taxes and tax rates paid by Buffett and his secretary, Debbie.

The first comparison (1) is made by Buffett in the media and is composed of three parts:

  1. Payroll taxes (Social Security and Medicare) paid by each individual.
  2. Payroll taxes paid on behalf of each individual by their employer.
  3. Individual Federal income taxes paid.

Buffett includes the portion of payroll taxes paid by their employer on their behalves, but ignores the corporate income taxes paid on his behalf by the companies that paid him dividends, which make up nearly all of Warren Buffett’s taxable income.

Dividends are taxed twice, once when earned as income by the company and again when the company pays the dividend to its owners.

Buffett and other commentators treat the low dividend tax rate as if it were a random and unfair artifact of the tax code.

Rarely is it acknowledged that there is a rationale for a lower dividend tax rate and it’s not just to make the rich richer.

Part of the rationale is that the combined corporate and individual tax rates on dividends is high at around 45% -50%. As Congress evolved the tax code — with the input from economists — one of reason they set the dividend tax rate low was to help offset the effects of the double taxation.

When the total dividend tax rate was higher, companies avoided paying dividends because of the high tax rate.  Some managers used double dividend taxation as an excuse to hold on to shareholder money and blow it in bad investments.

Others used a more tax efficient method of distributing money to owners — share repurchases.  Since there is no good reasons for the tax code to favor one form of cash distribution (repurchases) over another (dividends), dividend taxes were lowered to make both methods more equal.

But, therein lies the danger of such clever and complex systems: The next set of folks forget or don’t understand the rationale.  Or, perhaps they understand it, but choose to exploit (and feed) the misperception of low tax rates for their own political purposes.

To get a more apples-to-apples comparison between the real tax rates Buffett and Debbie pay (comparison 2), I estimated that the companies that paid dividends to Buffett had already paid $14 million in taxes on his behalf.  Now, this isn’t wholly accurate.  They really paid more (the real number is probably closer to $20 million), but I’m simplifying for the sake of understanding.

When I add the corporate taxes paid in, I find that Buffett pays a substantially higher tax rate (50%) than Debbie (37%) and the “Buffett rule” has not been violated. Not even close.

One final note: In addition to underestimating the amount of corporate taxes paid, some could quibble that my analysis ignores taxes Buffett paid when we earned the dividend-paying holdings to begin with.  That’s true and that means his dividends are actually taxed three times.  But, I thought just adding in what the company pays on his behalf in the current period should make a strong enough case for casual observers that Buffett and Obama are deceiving the public for political purposes.

Library ebooks hit snag

My local library reports that one reason their ebook selection is low is because four out of the “Big Six” publishers do not allow libraries to purchase their ebooks and the other two either have restrictive purchase policies are charge libraries more for ebooks.

In other words, these publishers are acting like Blockbuster in the early days of Netflix.

Change is a bear.  I understand wanting to cling on to profits from your traditional business model as long as possible.  But, just as Blockbuster learned, it works out better to be the change agent than the stick-in-the-mud.

Where does the Laffer Curve bend?

Laffer Curve

What is t*?

Thomas Sowell says that when tax rates are raised on high-income individuals, they respond to incentives by arranging their financial affairs differently to minimize those taxes.

Folks, like blogger Megan McArdle, lecture/patronize opponents of tax increases that current marginal tax rates are not near the bend in the Laffer Curve (the point where increasing tax rates would reduce revenue).

This is from Mark Perry’s blog, Carpe Diem:

The U.K. government is learning about the economic lesson that “if you tax something, you get less of it.”  Following an increase in the top marginal income tax rate to 50%, tax revenues from high-income taxpayers are falling, and are not going up, as the Treasury somehow expected by ignoring the economic lesson that “people respond to incentives.” A U.K. Treasury official explained the disappointing drop in tax revenues by saying it “was partly due to highly-paid individuals arranging their affairs to avoid paying the 50% rate.”  Duh.

Crowd source venture capital, please

I read this Wall Street Journal story about a Silicon Valley startup, Loyal3, with great interest.  This paragraph describes its business model:

Loyal3 has created an online app that would let companies sell, or even give, shares of stock directly to the public, with no brokerage fees, through a website or on Facebook, in increments as small $10. Small investors wouldn’t even have to buy a whole share. Loyal3 would let them buy and sell fractions of a share.

I thought it might be a step toward crowd sourcing venture capital.  Prosper.com has made it possible to crowd source loans.  I think crowd sourcing startup equity investments would be another good idea.  Essentially, to have a Shark Tank that you don’t need to be a billionaire to participate in.

I’m no expert, but I believe SEC regulations do not make this easy, or maybe even possible, mainly to protect small, unsophisticated investors like myself from being bamboozled by snake oil salesmen.

As I read on in the Wall Street Journal article, I realized that Loyal3 wasn’t the Prosper.com of equity investing.  Rather, it’s a bit more like a Sharebuilder.com, looking to fill a specialty niche in the investing market for small investors and for companies wanting to give out stock as a marketing campaign. A while ago, I believe you could buy shares in beer maker, Sam Adams, from the boxes of its 12 packs. Loyal3 basically helps with that.

I wish we could crack the crowd sourced venture capital nut.  Given low-interest rates and equity investments that do not seem all that diversified anymore, it would be nice to have another market for our investments.

And, with lotteries and casinos where you are almost assured to blow your money, I don’t buy the argument that we need to be protected from snake oil salesmen.

We shouldn’t have to donate to create jobs either.

A crowd sourced venture capital market might produce a few jobs and a few products and services that make our lives better in the process, as well as give investors access to early stage, higher reward (and admittedly higher risk) investing.

Uncommon Knowledge with Thomas Sowell

Thanks to commenter Jessica for the link to this video interview with Thomas Sowell.

I’m including the link, instead of embedding the video in this post, because the page has a handy segment reference guide.  The video is 46 minutes in total, but it’s easier to fit into your busy schedule in those 10-15 minute long segments.

About 13:30 in, Sowell explains his abrupt transition away from Marxism by describing his experience as an intern for the government over one summer:

I saw the level of understanding among the people [in government]…and I was in a program where we saw the top officials of the Labor Department…and I realized, these guys are not going to save us.

In the last segment of the video, Sowell discusses Republican presidential candidates.  This was around October.  Here are a couple of poignant thoughts that I enjoyed.

On Romney:  He’s a bland man who hasn’t offended anybody….I wish he would go back to doing that [creating jobs and successful businesses in the private market].

On Cain: The White House is not the place for on-the-job training, as our current President has illustrated.

Where do great ideas come from?

In the commercial below, Domino’s Pizza CEO, Patrick Doyle demonstrates a value destructive bias held by many big company execs when he starts the commercial off saying:

In a big company, good ideas don’t usually come from the local store level…

In this case they didn’t let that bias get in the way, because the commercial features a good idea that came from a Domino’s store owner in Findlay, Ohio, Brian Edler: Parmesan Pizza Bites.

Doyle is right in his follow-up sentence:

…but, a great idea can come from anywhere.

Just look at the beginning of Domino’s Pizza, or most successful companies.  Very few were designed in a boardroom at a corporate headquarters.  Two brothers founded Domino’s Pizza when they bought a single shop for $900 in 1960.

Subway Sandwich Shops and Subway’s $5 foot-long are other good examples.   The founder of Subway borrowed $1,000 to open his first store (again not designed in a boardroom).

And Subway’s $5 foot-long promotion was discovered by a franchisee in Miami.  Executives at HQ were not fans of the promotion, but other franchisees began adopting it on their own, because it produced results for them.  Eventually these franchisee results convinced corporate.

I’ve seen this attitude at many companies.  I’ve seen quite a few failures resulting from business models designed by bureaucrats and consultants in HQ.

Good ideas can come from anywhere, sometimes even competitors (Blockbuster?).  I would advise companies to cast their idea net as wide as possible and be as open-minded as possible.

Here I wrote about McDonald’s approach to innovation.  They have a test kitchen and they let their franchisees experiment.

“Why I Support Obama”: Point 1 – Addendum

In addition to what I wrote in my previous post, I’d like to add this short video from Richard Epstein.  He says government has the responsibility to “get out of the way”.  (Thanks to David Henderson of EconLog for the link).

 

His closing:

If we started to unravel that [all the government interference in health care], we would solve many of the access problems caused mainly by our own regulatory ingenuity, which somehow or another, always manages to backfire.

“Why I Support Obama”: Point 1

This my response to the first point made by the Facebook Obama Supporter.  Let’s first review her point:

For 30 years I’ve heard politicians talk about health care reform, and he’s the first one to do something about it.  The Affordable Care Act removes conditions on pre-existing conditions, makes health care more affordable for small businesses, raises the age at which children can be on their parents’ policies, removes lifetime caps, and more. With the possible exception of insurance execs, who would not want these changes?

First, politicians have been reforming health care for a long time.

Second, the Obama supporter doesn’t realize those reforms are why we have the problems that she wants the government to solve, like pre-existing conditions.

I wrote about how government created the pre-existing condition problem here.  John Cochrane, finance professor at the University of Chicago, agrees with me.  So does economist Steven Levitt.

Next, the Obama supporter believes Obamacare will make health care affordable for small  businesses. First, intentions of government programs are rarely realized. Usually it’s the opposite — the government programs make things worse. Second, affordability is partly caused by the government tax treatment of health insurance (see links in previous paragraph).  If we purchased health insurance like we do auto and home insurance, small business — or any business — could get out of the health insurance business and focus on whatever they do best.

Next, it’s not clear to me what problem raising the age for children to remain on their parents’ policy solves that wouldn’t be solved by decoupling insurance and employers as discussed in the previous two paragraphs.

Next, lifetime caps?  I haven’t heard of these caps being a problem.  And, in a freer market of health insurance, if people wanted protection over and above the lifetime cap, they could probably get it.

I’m not an insurance exec and I don’t want these changes.  I believe they will have negative unintended consequences that will slow progress and innovation in health care and lower quality and availability.

Plus, I bet insurance execs are not as upset by this as the Obama supporter thinks.  They are now politician’s cronies and as long as they keep their political cronies happy, the political cronies will keep directing our money to them.  That’s easier than developing innovative products that individuals choose over the competition.