Man Without Qualities

Wednesday, May 21, 2003

The Taxing Mister Buffett

Warren Buffett is again ranting - a trademarked, folksy, pseudo-populist, Middle Western rant, of course - against the President's proposed tax reforms. Specifically, Mr. Buffett argues against the President's proposed reform of the federal income tax on dividends:

Suppose this measure goes through and the directors of Berkshire Hathaway (which does not now pay a dividend) therefore decide to pay $1 billion in dividends next year. Owning 31 percent of Berkshire, I would receive $310 million in additional income, owe not another dime in federal tax, and see my tax rate plunge to 3 percent. And our receptionist? She'd still be paying about 30 percent, ...

Mr. Buffett's argument would make some sense if there were no federal corporate income tax. [Although Don Luskin does a wonderful job of deflating Mr. Buffett's approach even on its own terms.] But Berkshire Hathaway is already exposed to federal corporate income taxes at a rate of over 30%. The dividend income Mr. Buffett receives as owner of 31% of Berkshire Hathaway stock is already after [corporate] tax income. In contrast, his receptionist's income is taxed only once. Mr. Buffett's begin his tax argument only at the point of dividend distribution, and ignores the fact the federal government has already had a chance to devour over 30% of Berkshire Hathaway's own income out of which those dividends are paid. That style of argument really is what he condemns as "Enron-style accounting." Mr. Buffett's op-ed piece is really an argument for repeal of the corporate income tax in drag. That repeal would be a very good idea - even better than eliminating the tax on dividends as the President proposes.

Mr. Buffett's article also fails to articulate a rather substantial conflict of interest he has in making this argument: he would rather that Berkshire Hathaway retain its earnings so he can have the use of those funds than pay them in dividends to all of its shareholders. He admits - as he must - that Berkshire Hathaway does not now pay dividends. That decision not to pay dividends can be largely justified by the existence of a tax code that imposes full, economically irrational double taxation of dividends. He does not say what his (and therefore Berkshire Hathaway's) position on dividends will be once double taxation of dividends is eliminated. Indeed, he has of late made various public pronouncements to the effect that Berkshire Hathaway will likely not be able to resume its prior track-record of high growth. The Berkshire Hathaway annual report often points out that the company depends on retained earnings. If, as Mr. Buffett has now several times publicly admitted, Berkshire Hathaway can't use its retained earnings as effectively as it once did, then to that extent pressure on Berkshire Hathaway to dividend out its retained earnings increases. Double taxation of dividends insulates Berkshire Hathaway from this effect. Further, Berkshire Hathaway will likely feel this pressure to pay dividends even more than most public companies exactly because most of its stock is held by insiders. If Berkshire Hathaway's board - which is controlled by insiders representing the majority shareholders - continues to refuse to pay dividends, the minority shareholders will have good reason to ask whether such retention of earnings is intended only to benefit the Berkshire Hathaway insiders, especially Mr. Buffett. Such insider/public shareholder conflicts may not be enough to support legal action against the insiders for breach of fiduciary duty - but the markets will have their say when pricing Berkshire Hathaway stock. Mr. Buffett's failure to disclose in this article that the President's tax program will remove a major justification for Berkshire Hathaway to hold onto its retained earnings - retention that provides Mr. Buffett with his piggybank - represents yet more bad faith on his part.

Since Mr. Buffett has made - and apparently intends to continue to make - a big, public deal out of his personal taxes, it is only right that he actually tell the public how much he personally has actually paid in taxes for each of the past, say, ten, years. Perhaps Mr. Buffett has released his tax returns - but I have not been able to find a report of such an act on the Internet, although my searches have turned up lots of Mr. Buffett's preaching on tax matters - many of them invoking his own undisclosed tax position. One of the very curious aspects of the American tax system is that it allows - quite legally - very rich people to pay very little in taxes. Is Mr. Buffett one of those? If he is, then his whole argument would appear to stink of the worst kind of hypocrisy.

It is also interesting to note that George Soros - Mr. Buffett's sometimes ally in opposing President Bush's tax reforms, especially elimination of the federal death tax - did not join with Mr. Buffett in his most recent effort. Perhaps that has something to do with the fact that double taxation of dividends does not apply to most private companies - including all those hedge funds that Mr. Soros runs and has run. Modern private companies, including almost all hedge funds, are almost always structured as off-shore and/or "tax transparent" entities - such as limited partnerships or limited liability companies or even "S-corporations." Those entities pay no corporate taxes, but still give their owners the benefit of limited liability.

For the most part, in the modern world, only public companies have to pay taxes. And public companies are generally the only companies in which "the little people" - as Leona Helmsley termed them with her characteristic charm - have the chance to invest.

Buffett and Soros and Helmsley. On so many tax matters, birds of a feather.

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