15% or 30% for the 1% — 30 January 2012

Warren Buffet is a great investor, perhaps one of the greatest of all time.  But he is a terrible economist, and a worse policy advisor.

But he is revered, and because his views harmonize with President Obama’s, he is being held up as a paragon financial wisdom.  The “Buffet rule,” that a wealthy person shouldn’t pay a lower rate of tax than the salaried help, has not only been adopted by the president, it has been codified into a proposal unveiled in the State of the Union address:  that anyone making over a million dollars ought to pay a minimum tax rate of 30%.  Obama even sat Buffet’s secretary, Debbie Bosanek, in the First Lady’s box as a useful prop for the speech.

Obama’s impulse is, of course, “fairness,” but this policy is neither fair nor productive.  Let’s see what is really going on with those one per centers who pay the 15% investment tax.

Let’s say I’ve saved hard all my life (money that’s left after I’ve paid tax on it), and I have a tidy nest egg laid by.  I and several other savers decide to back a talented chef who wants to open a fancy restaurant with a million dollars each.  The first year is successful, and after all the expenses have been paid my share of the profit is $200,000.  Twenty percent return on investment, not bad.

Until the tax man gets hold of it.  First, the company pays 35% corporate tax, knocking my share down to $130,000.  Then let’s say we decide to distribute the profits – and I pay another 15% tax on that, about $20,000, so my net is actually $110,000.

Warren Buffet may not think so, but it looks to me like the government has taken 45% of my share of the restaurant’s profits.

If instead I choose to sell my piece of the business, the $130,000 is capital gains and I pay 15% on that, so the result is the same.  And it doesn’t matter if I am one of ten shareholders or ten thousand.  My pro-rata share of the earnings after expenses is taxed first as corporate tax and then again when the cash comes to me.  I’m paying way more than 15% tax.  And make no mistake – the $70,000 paid in corporate tax comes out of my share of the profits – that’s my money going to the tax man.

Now, as it happens, the talented chef makes a salary of $200,000, same as my share of the profits.  There are two big differences, though.   First, she is assured of her paycheck.  She has an employment contract that stipulates it, as long as the restaurant is in business.  My payday is dependent on what’s left after all the staff, purveyors, landlords, etc., are paid.  Second, her tax rate tops out at 35% – so she takes home $130,000 of her piece, twenty grand more than me.

There’s a big factor that the above hints at – I may not make any money at all.  In fact,  I might lose much or even all of the million bucks I put in to get the restaurant off the ground.  Clearly, I hope to make a nice profit on the place, enough that even if I keep only 55% of my share of the profits it will turn out to be a good investment – better than I could make if I put my million into something else.  But the payoff also has to compensate for the risk of calamity.

And now, Mr. Obama wants to cut my take-home even further, with a 30% tax rate (assuming I have a few investments and one of them nets me a big return).  That brings my net down to $90,000.  Do the math, and it means that the government takes 55% of the fruits of my personal risk-taking.  If you think this higher tax rate will make any investment prospect look like a better deal than it was at the lower rate, I suggest you apply for a job at the Obama White House.  The higher tax rate can not do other than inhibit investment, since it provides less return for risk-taking, and limits the number of investments that meet investors’ needs for after-tax return.

As for me, finding a gig that gives me a regular paycheck of which I pay only 35% tax is looking better and better.  But tell me, how many businesses do you think Debbie Bosanek has started?

Candidate Obama famously told Charles Gibson that he would be OK with a higher capital gains tax even if it brought in less revenue to the Treasury.  It was an issue of fairness, he told Gibson.  Redistribution is more important than funding the government.  Now we see quite clearly that he’s willing to sacrifice prosperity for the sake of the same ideal, even though the alleged unfairness of the 15% investment tax rate is phony.

This millionaire’s Super AMT will have two certain results – it will reduce capital investment because it will have become less profitable, and it will distort investors’ decisions as they try to time dividends or profit-taking so as to stay beneath the million- dollar threshold.  Both will act as a drag on an economy that is struggling even without additional headwinds.

I will say one other thing about the State of the Union Address.  Obama closed with a tribute to the Navy Seal team that killed Osama bin Laden, extolling their all-for-one team ethic.  “So it is with America,” he said, “…this nation is great because we get each other’s backs.”

Actually, this country is great because it is the spontaneous melding of many disparate purposes, not because we get each other’s backs.  It’s great because we’re free.  And that mission succeeded because it was a military effort: led by people who have been trained to command, and executed by people who have been trained to follow orders.  That may be Obama’s idealized view of America, but it’s certainly not mine.

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