Warren Buffet, one of my personal heroes, once said, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
Buffet, who was once the world’s richest man, now holds the number-three spot, and has made his fortune based on doing things differently. His philosophy on business could perhaps best be described by taking the time to do things right and treating people right along the way — something the world could use more of. This same viewpoint led Buffet to question why he, a multi-billionaire, was paying a lower tax rate than his secretary — a question that has now been echoed across the country.
Everyone hates taxes. Well, except for Uncle Sam. But we all agree that they are a necessary evil. Another thing that most people agree on is that people who earn more money should pay a higher tax rate. Unfortunately, this is not always the case. In 2011, the income tax bracket for a Head of Household went like this:
10%: $0-$12,150
15%: $12,150-$46,250
25%: $46,250-$119,400
28%: $119,400-$193,350
33%: $193,350-$379,150
35%: $379,150+
Clearly the intention is that the more money you earn, the higher rate you pay. In practice, however, this objective is rarely achieved with the super rich because tax brackets only affect earned income and not investments, which is where most of the rich’s wealth comes from.
Let’s take Warren Buffet as an example. In 2011, Buffet declared a taxable income of about $40 million. This is well over $379,150, so clearly he should pay 35 percent amounting to $14 million, right? Well, as much as President Obama would love that, Buffet only had to pay about $7 million, which amounts to 17.4 percent of his income. So what’s going on here? The reason Buffet pays so little is that the vast majority of his income comes from investments, where the tax rate is a flat 15 percent, regardless of the amount of money earned.
Tax rates on investments are kept low for a variety of reasons, the chief among them being to encourage investment. While this logic is sound in theory, many argue that, in practice, it falls apart. Say, for example, you have an investment that could potentially net $10 million. Some argue that if the tax rate on that investment increases from 15 percent to 25 percent, the knowledge you’re going to pay $1 million more on that $10 million you just earned is going to stop you from making that investment.
A second argument for keeping tax rates on the rich low is that they are the “job creators,” and if their tax rate is too high, job creation will plummet. This is an outstanding argument because while it is nearly impossible to prove, it is also incredibly difficult to disprove. Those who argue against it cite examples, such as that between 1980 and 2000, roughly 40 million jobs were added. Since the dawn of the George W. Bush era in 2000, there have been lower tax rates and far fewer jobs created. However, while this is a good point, it does not really “prove” anything, as nobody can say for certain that without the lower taxes, job creation would not have been even worse. Thus lies the beauty in basing an argument on a counterfactual.
Personally, I think it’s rather shortsighted to say that higher taxes hurt job creation, because rationally it just does not make sense. The logic is very similar to that of raising the investment tax rate. If a company is currently taxed at 35 percent, on the surface it makes sense to say, “Well, if the rate is increased to 40 percent, they will have less money and therefore hire fewer people.” As any economist will tell you, however, this is the wrong focus. The correct question to ask is whether hiring another worker will be a profitable decision for the company.
This is a decision independent of the tax rate.
Warren Buffet agrees with me, or rather, I agree with him, and that is why he has called on the government to take action — a call that has fallen on deaf ears. Over the past few decades, Buffet has repeatedly voiced his opinion that the super rich like him should pay more taxes.
He has said, “But I think that people at the high end — people like myself — should be paying a lot more in taxes. We have it better than we’ve ever had it.”
You would think that when it comes to financial advice from Warren Buffet, somebody would listen.
DANNY BRAWER would like to thank all his readers for their great questions and comments throughout the quarter. If you have any more, let him know one last time at dabrawer@ucdavis.edu.
