Warren Buffett's Hypocrisy and the Estate Tax

Last week, Warren Buffett, one of the world’s wealthiest men, “admitted” he was under-taxed and suggested that the US federal government should increase the tax rate for him and others at his level of income.

Many conservative columnists opined that Buffett should just write the US government a check for whatever “deficit” he feels he owes.

I merely want to point out Buffett's hypocrisy.

When Buffett suggests he is “under-taxed,” he is stating that the government has better uses for his money than he does (through his businesses, charities, or personal spending).  That may be true – or it may not be.  It really depends on the current condition of the world and US economy.  It is not always true that private businesses are more efficient with money than the government…or that private businesses will always be greater job creators than the federal government….(sorry Rick Perry, Sarah Palin, et al)... but it is true much of the time.

But back to Buffett.  OK, fine – he believes the government needs the money more than he or any other private organization does.

So let's take a look at Buffett’s estate planning. 

In the US, when you die, if you are worth more than $5,000,000, nearly 50% of your total net worth is going to go to the US federal government.

Now, don’t stay awake at night and worry about this.  In 2009, about 3 million people died in the US.  Of those 3 million, all of 15,000 owed the estate tax.

That’s right – only about ½ of 1 percent – or 5 out of every 1000 people who died owed estate tax.

Now, Buffett is estimated to be worth about $50 billion.  When he dies, his estate will owe between $20 to $25 billion to the federal government, unless he:

1)      gives it to his spouse (who then has to pay it when she dies) OR

2)      give it to a charity.

So guess what?  Buffett, who said last week he would rather give his money to the government than any other private organization, is giving nearly his entire estate of $50 billion to a charity.

http://money.cnn.com/2006/06/25/magazines/fortune/charity1.fortune/

Action speak louder than words, and Mr. Buffet's actions indicate that he believes the private sector, in this case, private foundations, can make more efficient use of his money than can the government. This, of course, isn’t the first time an extremely wealthy individual has decided he would rather have a private organization use his money rather than the US government.  Obviously, Bill Gates and his wife Melinda of Microsoft fame also made the same choice.  During the 20^th century, the Rockefeller, Ford and Carnegie Foundations are just some of the examples of very wealthy families getting out of paying a good portion of their estate tax by donating a substantial portion of their wealth to charity.

One very strong argument about keeping the estate tax in place (or “death tax” as its opponents like to call it) – is the ability to “force” wealthy individuals to give substantial portions of their wealth to charities. In fact, one study (by the non-partisan Congressional Budget Office) indicated repealing the estate tax would decrease overall charitable contributions by 30%.

Corporations are people too!

So Mitt Romney uttered the line “corporations are people” and liberals jumped all over him.

Would it have been better if Mitt merely said “corporations are a nexus of contracts” instead?

Frankly, part of the public’s misunderstanding (and hence mistrust) of the income tax system is exactly due to the lack of critical thinking that the liberals have shown here.

Democratic US Rep. Debbie Wasserman Schultz of Florida mocked Romney by asking “Does General Electric have human qualities?”

No, Rep. Wasserman Schultz – GE doesn’t have human qualities – but we don’t impose taxes on “human qualities” either.

Corporations really are made up of people.  You can argue that the corporate tax system (and regulatory system) sometimes allows really bad people to make large amounts of money at the expense of poor, under-educated individuals who have no control over their plight – but hey – at least allow the debate to be about who (as in people) get or are denied what because of the tax system.

The liberals here are engaging in a popular psychology ploy – describing the enemy in the most abstract terms – so people really don’t know anything about them – except they are “big, bad corporations.” Psychologists have found that the more you know about the other side, the more you may come to empathize, or at least understand, them and their motives.

Hollywood does a great job in many movies capitalizing on this psychology behavior in humans.  For example, in the movie “Independence Day,” the alien spaceship kills millions early in the movie through a huge explosive laser beam, but you really don’t feel their pain since you really haven’t been introduced to them in the story line.  After two hours of the movie, though, if Will Smith (who you now know) had been killed, that single death would have been personal and felt more than the millions to die previously.

In another movie, Die Hard 2, a group of terrorists overtake an airport’s air traffic control system.  First, they intentionally crash a plane.  The movie audience briefly (for 5 seconds) sees the airplane’s passengers as they are preparing to land.  As the plane explodes – you feel bad – but not terrible since you never “knew” anybody on the plane.

Liberals are doing the same thing now – maligning big bad "corporations" implies they are not made up of people.

Listen – corporations are made up of people.  When a corporation makes profits, the money can go to the government or to other companies or to shareholders or to employees - including those “already filthy rich executives.”

But the money is going to people.  In order to even begin a critical discussion of how much each of these entities is entitled to - and how, if and when the tax system needs to be involved in this distribution system – you need to at least acknowledge that fact.

My doctoral dissertation in economics at Notre Dame examined something similar – what is the effect of large management buyouts on various stakeholders to a corporation (by stakeholders, I mean the US government, employees, and current and future shareholders - all ultimately "people").

Basically, I found that these buyouts (where management takes a company “private”) benefits current and future shareholders tremendously – at the cost of hundreds or thousands of employees losing their job and the US government taking in less money from tax revenues than it would have otherwise.

In Mitt Romney’s old job, he was on the receiving end of these buyouts - to the chagrin of undoubtedly thousands of former employees – and the delight of thousands of shareholders.  He knows all about “people” involved in corporations.

But at least he is ready to engage in the conversation.

And as for Debbie Wasserman Schultz - don't look for her to announce that "labor unions are not people"  anytime soon.....

Stock market crashing, capital losses and tax reform

So yesterday, while I was returning from Denver (elevation 5,280) to Dallas (elevation 430 feet), the stock market decided to make a similar journey.

In case you didn’t know it, you can deduct your losses on tax return (Form 1040) to the extent of  $3,000, less any gains.

I think I already told you in a prior blog that they haven’t indexed that $3,000 for inflation in nearly 35 years (if they had, it would be worth around $10,000 now).

Today Obama again mentioned hopes of tax reform.  One way he could do this is to make this deduction “fairer” – and by fairer, I mean more helpful to the small investor that has lower taxable income.

The absence of the small investor right now (outside of retirement accounts) is partly to blame for the wild swings in the stock market during the past few years – many trades are being made either by hedge funds or big brokerage firms, who enter and exit the market much faster and more often than the small investor.

But the small investor has little reason to come back – including the fact that the $3000 loss deduction is seriously benefiting high income taxpayers and not "middle" America.

The reason why is that the tax costs of the gains versus the tax benefits of the losses are not symmetrical. Because of that, high income taxpayers get a much better deal on their losses than low income taxpayers.

Let’s start with the first item – symmetry.  If your taxable income is $500,000 per year, you’re in the 35% bracket.  If you have an additional gain on sale of stock – say a $3,000 gain – it is taxed at 15%.  So you pay $450 more.

Now suppose instead you have a loss of $3000 at 35%.  You end up paying $1050 less in taxes. 

That’s right – UP and you owe $450 to the government, DOWN and you get back $1050.

Suppose your taxable income is $30,000.  You get a gain of $3,000 – you pay tax on it at 10% - $300.  Down and you pay $300 less in taxes as well.

Let’s see – UP and you owe $300 to the government, DOWN and the government owes you $300.

Just another reason why you would rather make $500,000 a year than $30,000.

Instead of correcting disparities like this, presidential candidates (former Governor and 2008 Presidential candidate Mike Huckabee of Arkansas comes to mind) become obsessed with these “pie in the sky” ideas like FLAT TAX (!!) (as if the Flat tax is going to fix all the problems – but I will cover that in a future blog).

FAA tax, my trip to Denver and I am bummed out....

I am bummed out.

In case you haven’t been following this – the Federal Aviation Adminstration tax (which is about 10% of your airline ticket cost) was “suspended” on July 22 due to disagreements between the HofR and Senate.  This tax pays for the construction of new airport expansions.

If you paid for your ticket before July 22 (which I did for my Dallas to Denver flight), and flew both ways BEFORE Congress reinstated the tax, you might be able to petition the IRS for a refund (Delta and United were both offering simply to refund the tax on your credit card).

Unfortunately, before I got back to Dallas from Denver next week, the tax was reinstated… so no refund for me... in fact, Obama signed the bill into law today, painfully while I was in the air to Denver....

You can read about it here:

http://www.reuters.com/article/2011/08/05/uk-congress-reaches-deal-to-end-faa-shut-idUSLNE77400A20110805

An interesting tax “phenomenon” occurred when the tax was dropped two weeks ago.

Typically politicians will say that instituting a tax hike will penalize consumers with higher prices. 

This whole FAA tax suspension proved that is not necessarily true by proving the reverse.

When the tax was suspended, you would have expected prices of airline tickets to drop.

For example, if the price of the ticket was $300 before the suspension (based on $270 for the flight and $30 for the tax), you would have expected the price to decrease to $270.

Guess what happen?  Airlines simply all raised their fares $30 – so they were still collecting $300 per ticket.

A tax cut – or a tax hike – does not mean that the consumer will pay less or pay more.  In this case, a strong oligopoly (few companies controlling most of the airline tickets) could coordinate their action to insure they got all the money from the tax cut.

Cutting taxes doesn’t always mean more money for consumers – corporations could simply keep the money and increase their net income (or pay workers more, or reinvest in operations more, or pay more to shareholders). 

Raising taxes doesn’t always mean higher prices for consumers – corporations might be forced to keep prices the same and pay the tax themselves – thereby reducing their net income.

Similarly, if Congress were to increase the gas tax, or increase the taxes paid by oil companies on their income – it doesn’t necessarily mean that consumers would pay higher prices at the pump – corporations could simply make less income.  It all depends on the supply and demand forces working within that sector of the economy at the time.

In four words – “well, it all depends….”

Denver, Colorado here I come this weekend!

Off to Denver this Friday for the American Accounting Association's national meeting - where nearly 3000 accounting professor will all be in one place at one time.

One of the luncheon speakers is Paul MacCartney's sister - Ruth - who will speak on "The Role of Social Media in Education."

And who said accounting profs weren't cool?!!

Debt deal ready for passage - absent a shock - next few months interesting.

The bill (soon to be law) contains requirements for additional spending cuts, plus some elements of tax reform.

That should make for some interesting discussions on this blog for the next few months.

One thing to point out though - Obama didn't fail to increase taxes on the wealthy.  He failed to increase taxes on people whose taxable income exceeded $200,000.

The headlines always say "raise taxes on the rich" or "fails to raise taxes on the wealthy" - but that isn't the case.  The federal government doesn't tax wealth (unless it's the estate tax which is such a small portion of tax revenues, it can be ignored for this discussion).

The federal government taxes taxable income.  Period.

Now, of course, you can argue that wealth and taxable income are heavily correlated - and you're probably right most of the time.

But it is a smart tax-literate person who can figure out how to disconnect the two. (It is usually done through years of savings, squirrelling away money into investment vehicles that don't pay current taxable income, and reaping returns on investments which produce income that is not currently taxable - think some stocks, real estate, etc.).

Take as an example, Mr. Miser's portfolio of assets totaling $2,200,000 (and assume he has no debt):

Non-dividend paying stock     $1,000,000
401(k)                                         $500,000
Land holdings                             $300,000
Personal residence                      $400,000

Suppose Mr. Miser's salary from his job last year was $100,000, and each of his investments listed above grew 10% for the year. 

How much taxable income does he have?  Easy - just his salary of $100,000 (less some deductions). None of his investments listed above will appear on his 1040 tax return since none produce taxable income in the current year.

How much did his assets grow?  Well, his total assets listed about were $2,200,000, so he "made" another $220,000 on that - but none of that is currently taxable.  Total income - $320,000.

So Mr. Miser is wealthy - he is a multi-millionaire - he made over $300,000 last year - but his taxable income is "only" $100,000 (less some deductions) - and he won't register on Obama's "tax increase on the wealthy" list.

And no, the tax reform you're going to see over the next few months isn't going to change any of those rules.