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Sunday, September 4, 2011

Warren Buffett is wrong and so are you




Warren Buffett may genuinely believe that paying more taxes is the right thing to do. I don't know, I'm not a mind reader. But it is also likely he says this because he only wants to pretend he cares. After all, he could donate his wealth to the government or to those in need...right now...rather then when he's dead and no longer has a use for it.

It is also a possibility that he's advocating higher personal income taxes and higher capital gains taxes to protect the wealth he's already accumulated. One of the best ways to protect your wealth is to make sure there isn't competition and that means taking the income from others that could be used to create new wealth. After all, he's not actually advocating a tax on wealth - just income, however earned.

Again, I don't know Buffett's motivations... I just know he's wrong.

Defending Warren Buffett's claim that his receptionist pays more as a percentage of her income in taxes than he does, Gerald Swanson (a self proclaimed former employee at the U.S. Treasury) writes in the Reno Gazette Journal,

Tax on capital is 15 percent. Earned income: W-2 wages are taxed 15.3 percent (Social Security/Medicare) and income tax 10 percent to 35 percent. Combined tax on earned income at lowest level is 15.3 plus 10 equals 25.3 percent, and tax at the top marginal rate is 15.3 plus 35 equals 50.3 percent. 
Earned income is taxed more than three times as much as capital.

First, the capital gains tax is in fact 15 percent on income earned from dividends. Dividends are a share of the profits paid out to shareholders of corporations. However, dividends are paid on post-tax profits. The corporate income tax in the United States goes as high as 38 percent. In other words, the corporation pays an income tax then hands a portion of the profits over to shareholders who turn around and pay yet more taxes on the income.

Second, Gerald's math is rather ironic. The payroll tax is indeed 15.3 percent if you employ yourself. If you are employed by someone else then you pay 7.65 percent of your income and the employer pays the other half. Technically, the employee sees their income drop by 15.3 percent. Additionally, the bulk of this tax only occurs on about the first $105,000 of income. Of course, Gerald ignores this in his math.

That said, you don't assume a total personal income for the receptionist of $30,000 and a 15.3 percent payroll tax, because the payroll tax is actually 7.65 percent of her income. The other half is paid by the employer. If Gerald wants to use the 15.3 percent combined individual and employer contributions on the payroll tax he has got to add that employer contribution back into the receptionists income. He doesn't do that, he just ignores it on order to overstate the taxes she might pay.

Quick, cover your ears, don't listen to this Buffett!

Third - math time. Gerald argues that the combined payroll tax and top marginal tax rate (note Gerald ignores the $3,700 single exemptions, $5,800 standard deduction and the fact that the payroll tax falls to 2.9 percent after the first $105,000 of income) = 50.3 percent. He concludes this is 3 times higher than the capital gains tax. But when you take into account the capital gains is double taxed (once as a corporate profit and again as a capital gain) then the tax is 53 percent.

In other words, the capital gain could be as high as 53 percent while the $30,000 a year receptionist pays 25 percent - less deductions. That said, doing the taxes properly  (assuming she's single and has no dependents) means the receptionist would actually be paying about 18.7 percent of her income in taxes plus the employers contribution of the payroll tax.

Next, Warren Buffett isn't talking about a wealth tax, as Gerald seems to imply. Warren Buffett is talking about increasing personal income taxes and capital gains taxes. A capital gains tax is not a tax on accumulated wealth (the billions Warren Buffett already has) but rather the millions he makes from the billions he owns. This is why I'm suspicious of Mr. Buffett - he's already made it and by increasing taxes it makes it harder for others to challenge him or his empire. I could be entirely wrong, but this is a red flag for me.

Ah...a Buffett you can listen to without regret.

Next, in regards to deferring capital gains. I'm no tax expert - and by this point it should be clear Gerald Swanson isn't either. While it is possible to defer capital gains indefinitely, deferring the gains is not without its own costs. For example, one way to defer your capital gains tax is to lose money on other investments. Warren Buffett took some major losses in this recession so its easy to see why his capital gains tax would be lower than otherwise. It also isn't a surprise he's pro corporate bailout either. Another  way to defer capital gains is to make large contributions to charitable trusts. If you'd like to learn more talk to a CPA or a tax lawyer...just don't talk to Gerald Swanson.

Finally, the only reason Warren Buffett may pay less taxes as a percentage of his overall income is only because he a) misleads the public in regards to double taxation of capital gains income and/or 2) he pays CPAs and tax lawyers to keep his tax burden low.

UPDATE: Included the deduction and exemption amount and made a proper tax calculation that more accurately reflects what the receptionist might pay.

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