Will Warren Buffet Move The Needle On Tax Reform?

February 27, 2012 – 10:48 pm – No Comment

Warren Buffet finds himself in the news often these days. He may be 81 and reside in the relative silence of the Midwest, but Mr. Buffet is still going strong and is becoming ever more outspoken. He has become the Obama Administration’s strongest proponent on “shared sacrifice” in achieving tax reform, advocating for higher taxes to be paid by the rich. The media has even deemed a portion of Obama’s proposed tax reform, the “Buffet Tax.” Mainly, though, he continues to head his conglomerate, Berkshire Hathaway Inc., as he has done so since 1970. The holding company has interests in a number of diverse business activities, including insurance and finance, rail transportation, energy, manufacturing, and retailing. Last December, Berkshire even acquired Buffet’s hometown newspaper, the Omaha World-Herald.

Berkshire recently released its 2011 annual report, which included the much anticipated “Chairman’s Letter”, where Buffet highlights Berkshire’s current investment strategy and reflects on the broader business landscape. He also sat down for an extended interview on CNBC, which generated greater insights into what the so-called “Oracle of Omaha” is thinking these days. At a time when approval ratings are low for corporate America, Buffet is bucking the trend as his admirers grow and he rids himself of the David Sokol – Lubrizol controversy of last year. His appeal to the masses is easy to understand, as he truly puts his money where his mouth is and is extremely generous. This is evidenced by the fact that 98 percent of his net worth – ~$40 billion – is tied to Berkshire stock, and the fact that Buffet has pledged to give away 99 percent of his fortune to philanthropic causes, primarily via the Gates Foundation.

My take-away from both Berkshire’s annual letter and his CNBC interview is that Buffet is relatively optimistic on the future of his businesses and the economy as a whole. Below, I’ll lay out a few of his main points as they relate to tax reform. In later articles, I’ll incorporate Buffet’s analysis as it relates to the future profitability of banking, a possible recovery in housing, and the strength of the tepid economic recovery in the United States.

“Taxes are the price we pay for civilization.” Those were the famous words of Oliver Wendell Holmes, the former Supreme Court Justice. Besides seemingly Ron Paul and his supporters, Americans agree that taxes are a necessary evil in exchange for a functioning government. But who should pay taxes? What tax rate is appropriate – for businesses and individuals? How about investment income? These questions aren’t easy to answer, and are a contributing factor to the deep partisanship that exists in Washington and has recently served as debate fodder for both the Tea Party and Occupy Wall Street movement.

The implications of tax structure changes will impact the economy greatly in the next decade and will always remain a hot-button political issue. As the 2012 election approaches, I expect the rhetoric to continue to heat up as we’ve already seen a number of major tax reform packages being offered by both parties. Also, the framework for taxes within the Bowles-Simpson fiscal reform package will play a role (hopefully, a major one) in the debate going forward.

Significant differences do exist within the various plans, including how to tax the wealthy or how to tax corporate earnings held overseas, but the two main objectives are simplification and fairness. On the former, depending on how you count, the Internal Revenue Code is somewhere around 3,000 pages long and has 7 times as many words as the Bible. On the latter, Americans are frustrated when they see large, profitable companies such as GE paying little in taxes while they are struggling to live paycheck to paycheck and feel they themselves are deserving of a tax break. Many corporations pay a tax rate far below the top marginal rate and the statistics are mind-boggling: GE paid a negative tax rate of minus 13.5 percent of their profits in federal income taxes between 2008 and 2010, according to the Citizens for Tax Justice. Information technology companies paid taxes at a 2.5 percent rate, utilities companies at a 3.7 percent rate, and financial corporations at a 15.5 percent rate.

Back to Mr. Buffet, who has come out in strong favor of the Obama Administration’s tax policy positions. This includes repealing the Bush tax cuts on the wealthiest Americans (including Buffet of course). Buffet’s go-to argument when expressing his agreement on increasing the top individual rate from its current 35 percent to 39.6 percent is pointing out that he pays a lower effective tax rate than his secretary, after adding in the payroll tax. This is, of course, due to the nature of our tax system. Earned income is usually taxed at a much higher rate than capital gains, from which Buffet generates virtually all of his income. Thus, Buffet’s effective tax rate is 17.4%, while his secretary’s rate is 34%.

No doubt, repealing the Bush tax cuts will be central to Obama’s election strategy this year, and I personally think it’s an issue he can exploit the GOP on. Mitt Romney (assumed nominee at this point) will face trouble explaining to the average voter that all taxpayers in the highest bracket are “job creators” and are already paying their fair share. This is a legitimate argument, considering the top 1% of earners are responsible for 40% of the federal tax burden. However, Obama, with support from Buffet, George Soros and others seem to be winning this argument. It especially won’t help Romney’s case when more voters become aware of his effective tax rate of 15.4%. (although he did donate ~$7 million to charity)

On the corporate side, Buffet also believes corporations should be paying more to the government. That’s saying a lot, considering Berkshire paid $2 billion in taxes last year, or more than one percent of all corporate taxes in the U.S. The Obama Administration’s new corporate tax reform plan would accomplish an increase in revenue. Although it would take the top corporate rate from 35 percent to 28 percent, a large reduction in tax loopholes and subsidies would result in a net positive to revenue generation. Buffet’s comments from the CNBC interview revealed his thinking on corporate taxation and he once again used effective tax rates to make his point.

“The interesting thing about the corporate rate is that corporate profits, as a percentage of GDP last year were the highest or just about the highest in the last 50 years. They were 10 and a fraction percent of GDP. That’s higher than we’ve seen in 50 years.”

He continued: “The corporate taxes as a percentage of GDP were 1.2 percent, $180 billion. That’s just about the lowest we’ve seen. So our corporate tax rate last year, effectively, in terms of taxes paid for the United States, was around 12 percent, which is well below those existing in most of the industrialized countries around the world.”

It’s hard to argue with statistics like that, and I agree that corporations should pay their fair share. For me though, it’s more about consistency in the approach to dealing with tax reform. Companies should be confident in being able to estimate their tax liability for the coming year for budgeting purposes, corporate strategy, etc. The uncertainty surrounding taxes and the other big elephant in the room, health care reform, have been a net drag on business and hiring in the past few years. A consistent, pro-business message coming out of Washington can do a lot for business investment and confidence. I would like to see a broad overhaul where the rates are lowered, the tax base is broadened, and the special deductions/exemptions are reduced. I realize this won’t happen during an election year, but during the next presidential term, whether Democrat or Republican, tax reform is a must for the future vibrancy of our economy.

Zach is a junior student at the University of Iowa majoring in accounting, economics, and finance. Zach worked for over a year in portfolio management at AEGON USA in Cedar Rapids, IA. He has competed in many business competitions throughout the Midwest during his time at Iowa. After college, Zach looks to move to New York or Chicago, and work in high finance. Follow Zach on Twitter @zachhalstead