Headlines that make you go, hmmm….

#1: A local NBC affiliate reports: Zuckerberg Joins Buffett, Asks for Higher Taxes

#2: Forbes magazine reports: How Facebook Billionaires Dodge Mega-Millions In Taxes

From the Forbes article:

Facebook billionaire cofounders Mark Zuckerberg and Dustin Moskovitz are both 27, unmarried and have no children we know of. Yet back in 2008 they both set up grantor retained annuity trusts (GRATs) that we estimate will allow them to transfer a total of at least $185 million of wealth to future offspring or others, gift tax free. That compares to a supposed gift-tax exemption of just $1 million in 2008 and $5.12 million today.

Granted, Zuckerberg may not have had his tax epiphany yet in 2008. I’m assuming he’s moving swiftly now to dissolve this tax dodge trust.

#3: Buffett writes: Stop Coddling the Super Rich in the New York Times about how the super wealthy should pay more in taxes, inspiring Obama’s Buffett rule proposal.

#4: Reuters reports: Government sues Buffett’s NetJets Unit for Unpaid Taxes

I have no problem with folks legally minimizing their tax bill.

I do have a problem when these same folks get the positive glow from voicing their opinion that their tax bill should be higher, without putting their money where their mouths are.

Of course, what really annoys me about this thread is that the whole thing is a giant red herring that misses the key issue: government spending.

Let’s say we do raise taxes on the super rich or that Buffett and Zuckerberg stop talking out of both sides of their mouths and decide to voluntarily pay more in taxes. Let’s go even further and assume that either of these efforts actually increase government revenue.

Which result do you think is likely?

A. Government maintains spending, so the extra revenue reduces the deficit.

B. Government increases spending, so the extra revenue leads to more government spending and does not reduce the deficit.

I would appreciate anyone who believes (A) is likely to provide evidence. Do we have any experience where higher government revenues were not accompanied by higher spending over a 2 – 5 year period?

I’d like to know which Buffett and Zuckerberg thinks is likely or if they’ve even given it much thought. If not, then they could do all us all a favor by 1) thinking about it and 2) using their voices to shine light on the real issue: government spending.

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.

Good points for Buffett to consider

Thanks to W.E. Heasley of The Last Embassy for providing a link to this article from the American Enterprise Institute’s magazine, The American.  The article is titled, Obama’s Folly: Why Taxing the Rich is No Solution.

I enjoyed this article because it’s a good example of a well-argued position.  The authors do a fine job of properly characterizing their opponents’ argument that the wealthy should pay more taxes. They don’t resort to inaccurate straw men.  We could make much progress with debate in this country if more people could do this. That would be a great course to add to our public education curriculum–how to accurately characterize your opponent’s position.

The authors also provide many valid points for their opposition to consider and none of it is about coddling the rich.

Their examination of the numbers should be sobering to the tax the rich folks:

According to the New York Times, the president’s plan to abolish the Bush tax cuts for those making more than $250,000 is expected to bring in merely $0.7 trillion over the next decade, or about 0.4 percent of Gross Domestic Product per year. As a comparison, the Congressional Budget Office estimates that the deficit over the same period is going to be $13 trillion, more than 6 percent of GDP per year.

If this is accurate, then it alone should end the debate.  Focusing so much attention on taxing the rich brings to mind the old saying to be penny wise but pound foolish.

Next, the authors address what has become a popular argument put forth by a member of President Obama’s advisory board, Laura Tyson, and published in The New York Times:

The most common fallacy repeated by Tyson is that taxes do not matter because the economy was booming during the Clinton years even though taxes went up.

They go on to point out that the 90s had other economic events as well — NAFTA, welfare reform and the Internet boom — to name a few.

I’ll add that in 1997 significant reductions were made in the capital gains tax rates for assets held more than one year (source), so not all tax rates for the wealthy increased.  I’ll also add that much of the increase in tax revenue in the last part of the 90s came from capital gains taxes.

The authors correctly point out:

Instead of picking one historic event that happens to fit your preferred theory, a more reasonable approach is to investigate all historical periods where taxes increased or decreased.

This has been done by former Obama advisor Christina Romer and her husband David Romer. They also take into account the causes of tax increases.1 They find that tax increases tend to reduce economic growth, stating that “tax increases appear to have a very large, sustained, and highly significant negative impact on output,” as “an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent.” Similar results have been obtained by Harvard economist Alberto Alesina using a different methodology.2

I don’t trust studies like that of the Romers.  However, their finding is not surprising.  It’s called incentive effects and believe it or not, they exist.  Believe it or not, you respond to them everyday of your life, whether you realize it or not.

But other people put more stock into statistical studies.  Many of those people also think we should raise taxes on the rich.  So, the Romers’ studies and the other economic events of the 90s should at least give those people something to consider.

I also appreciate the authors’ encouragement to look at more than one data point on which to draw our conclusions. That’s great advice.  When someone does that, or when you do it yourself, your skepticism should rise.

Here’s why.  Do you think it would be tough to find one data that says the opposite?  I doubt it.

I appreciate actual experience over conjecture.  But to focus on a single time period and neglect other important factors (like the reduction in capital gains tax rates) is not good practice.