Watch What the Rich Do, Not What They Say

Guest post by Kris Sayce of Money Morning Australia

“Back in the 1980s and 1990s, tax rates for the rich were far higher, and
my percentage rate was in the middle of the pack. According to a theory
I sometimes hear, I should have thrown a fit and refused to invest
because of the elevated tax rates on capital gains and dividends.”
– Warren Buffett, op-ed, New York Times

Mr. Buffett says the U.S. Congress should raise taxes on the rich.

He says he’s so rich he should pay more tax.

Then why doesn’t he?

According to the U.S. Treasury, during the 2010 financial year $2.8 million was donated as “Gifts to reduce debt held by the public.”

That’s right. Americans who choose to can make voluntary contributions to the U.S. Treasury to cut the national debt.

Trouble is the U.S. has a national debt over USD$14 trillion.

That meant, in 2010 the U.S. Treasury’s interest expense was a whopping USD$413.9 billion.

Put another way, the $2.8 million donated reduced the national debt for…3.5 minutes… before interest costs wiped it out!

This financial year the donation wipe-out will take even less time. The interest expense is already at USD$412.5 billion… and will likely increase by another USD$50 billion over the next two months of the fiscal year.

It’s no wonder so little is raised through donations.

Buy an investment or pay more tax?

Certainly Mr. Buffett and his rich pals see little point. With all their wealth, they’d surely donate more than USD$2.8 million.

After all, Mr. Buffett could double the amount donated to the U.S. Treasury each year by handing over just 0.007% of his personal wealth.

Or, if he’d prefer, he could get his listed firm, Berkshire Hathaway [NYSE: BRK-A] to make the donation. It’s not as though his firm is short of a few bob. According to Bloomberg News, Berkshire Hathaway has “$47.9 billion of cash”.

Or, he could have donated to the Treasury rather than buying 1.5 million shares of U.S. listed firm, Dollar General [NYSE: DG]. A stake that would have cost his firm over USD$40 million – 14-times the sum donated each year to the U.S. Treasury.

What point are we making?

First, it gives you another example of how stuffed the U.S. economy is. And why you should be wary about getting suckered into this one-week suckers’ rally.

For all the talk overnight about markets rallying on the back of takeover activity, the U.S. economy is just as stuffed today as it was two weeks ago.

But second, it highlights how you should pay more attention to what big investors do rather than what they say.

If Buffett’s real concern was paying more money to the federal government then he’d just do it. Making a gift to the U.S. Treasury to pay down the debt is simple: write a cheque and send it off to Parkersburg, West Virginia. (Amusingly, the Treasury also accepts credit card donations!)

But helping out the federal government isn’t his real concern. Bloomberg News gives away what’s really on Mr. Buffett’s mind:

“Berkshire’s equity portfolio was valued at $67.6 billion as of June 30, with 40 percent in consumer products firms and 37 percent in financial firms such as banks and insurers. The rest of the portfolio was in a group Berkshire labels ‘commercial, industrial and other.’”

In other words, you’re looking at a portfolio of economically sensitive stocks. Stocks that rely on an economy not going into recession.

Why higher taxes won’t help

But here’s the biggest flaw in Mr. Buffett’s plan. In his op-ed for the New York Times (where else, it’s like expecting the Age to print an op-ed calling for tax and spending cuts) he makes the point that the income of “the highest 400 [wealthiest people] had soared to $90.9 billion.”

Of this – he calculates – USD$19.5 billion was paid in taxes.

But here’s the thing, Mr. Buffett doesn’t reveal how much more taxes these people should pay. Think about it, an increase in taxes to USD$30 billion would mean an extra $10.5 billion and cover just 2.3% of the interest cost of outstanding U.S. debt…

Or wipe just 0.00007% off the federal debt.

Perhaps he thinks his rich pals should be taxed at 100% of their income? But even so, it would cover just 20% of the interest expense or wipe a measly 0.0006% off the federal debt.

Now, we can’t speak for the rich, but we’re pretty sure a tax burden of 100% would cause them – in Mr. Buffett’s words – to throw a fit and refuse to invest.

If you’re taxed 100% of your salary this year, what are the odds on you bothering to earn anything next year?

The simple reason more people don’t donate money to governments is because they know it’s not an effective use of capital. Mr. Buffett and his rich pals know for a fact if they invest money rather than donate it to government, everyone’s a winner.

The rich guys hopefully get a return on their money… the people the rich guys bought the investment from make money… the people that work for the firm they bought get to keep their jobs and perhaps more people will be given jobs… and consumers who use the goods or services produced by the company continue to get the goods or services they want.

Contrast that to government services which are things people either don’t want, or want but don’t want to pay for.

The fact is – and Mr. Buffett of all people should know this – government is a handbrake on any economy. It’s not the throttle.

Creating innovation from destruction

Economies are built on innovation and individual entrepreneurial spirit. An economy isn’t built on a democratically elected dictator swiping wealth from individuals to use as bargaining chips to secure election or re-election.

If Mr. Buffett was concerned about the future of the American economy he should call for a wind-back of the state. And with it, lowering the tax burden on entrepreneurs and successful businesspeople. That’s a simple way to increase wealth for everyone.

Instead, like all people in powerful positions and influence the goal isn’t to spread the wealth – it’s to keep theirs and make sure others spread their wealth.

Because winding back the tax burden and cutting regulations is the last thing an existing businessman or woman wants. Companies that are brand leaders and market dominators (the kind of firm Mr. Buffett invests in) also happen to be the direct enemy of the entrepreneur.

Entrepreneurialism and creative destruction are the true drivers of economic progress. But they can only drive progress if given the chance. Wealthy people calling for higher taxation on other wealthy people won’t do a darn thing to help.

All that will happen is the Feds will keep spending while the wealthy find new ways of avoiding a higher tax bill… and that means a bigger burden on the middle classes, more debt, bigger government and less innovation.

But don’t expect anyone in a position of influence to figure this out anytime soon.

Cheers.

Kris Sayce
Money Morning Australia