Wednesday, August 17, 2011

Buffett The Hypocrite

Almost everyone argues their interests on tax reform, including Warren Buffett. Buffett is in favor of increasing taxes that he doesn’t pay. Estate tax? Buffett isn’t paying it, he’s giving his fortune away to the Gates foundation, largely. Income tax? Relative to the increase in his net worth, Buffett pays almost nothing in taxes because we don’t tax stocks until a dividend is paid, or until some stock is sold. What’s more, BRK has a $38 billion deferred tax liability, which measures taxes that would have been paid on GAAP income, but weren’t paid because taxable income was lower for reasons that may revert, someday.

So, he's a hypocrite on taxes. Let him argue for the following:

1) Unrealized gains on assets should be taxed each year, for corporations, partnerships, and individuals. Losses should receive deductions.

2) Eliminate deductions/credits from the personal and corporate tax codes. We could eliminate the deficit instantly with that one simple change. Don’t use the tax code for social engineering.

3) Tax corporations on their GAAP income, or better, whatever they represent to investors as the true increase in period-to-period net worth.

4) Add in an EBITDA tax on private equity, and everything like it, such that we assume a 15% ROE for tax purposes that trues up when the partnership closes. Everywhere, make the tax basis equal to GAAP, or modifed GAAP, where it exists. Where it doesn’t exist, make the taxes punitive enough that adopting GAAP is preferable.

With the present tax rates, implementing all of these would put the budget in a decided surplus, WITHOUT RAISING RATES. You would even eliminate the estate tax, because estates would finally be taxed year-by-year. The tax code would then be close to fair, like some contend it was with TRA ’86.

But there is one place where I agree with Buffett entirely:

People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

Taxes affect business decisions when the definition of taxable income gets changed or credits get offered. Examples are section 42 housing credits, and in insurance company accounting, as well as private equity and with clever investors that max out debt while growing net worth.

In that sense, the definition of income, and the offering of credits make a huge difference in the behavior of those taxed. But within reason, tax rates don’t make that much difference. Yes, up 10%, there will be some effect on economic activity. The bigger changes come from deductions and credits.

You want a pro-growth tax code? Eliminate the deductions, credits, and deferrals. Tax us year-by year on an estimate of our increase in income including unrealized capital gains and losses.

Yes, there will be unemployed accountants, actuaries, attorneys and administrators. But the system as a whole will be better off, and for once, who will argue in favor of preserving the nation, and ignoring special interests?

What Buffett suggests will get little in the way of results. A focus on defining income properly will bring in more than sufficient taxes, and especially from Mr. Buffett, one of the least taxed relative to the increase in his net worth.