Tuesday, September 27, 2011

Hero or Hypocrite? “The Buffett Rule” Then and Now

 “The first rule is not to lose.  The second rule is not to forget the first rule.”
—Warren E. Buffett, quoted by Carol J. Loomis, Fortune Magazine, 1988

 Having recently celebrated his 81st birthday, Warren Buffett is not going softly into that good night.  He is, in fact, going quite noisily ahead, making new friends—and new enemies—along the way.
 His most visible friend, of course, is President Obama, who has gone so far as to name a new tax proposal after him (“The Buffett Rule”), following the Oracle of Omaha’s August 14 op-ed piece in the New York Times calling for higher tax rates for the rich, as follows:
“I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more…I would suggest an additional increase in rate.”
 Buffett’s most visible enemy, now that his long-submerged but never denied personal brand of liberal Democrat politics has burst, full blown, into the open, is a collection of bloggers, politicians, political commentators and billionaires taken to excoriating Buffett for his high-minded, highly visible, and, they say, highly misguided stance on tax policy.
 The centerpiece of the criticism is pretty straightforward: if Buffett feels so strongly about paying higher tax rates in the interest of fairness, nothing is stopping him from setting the example by voluntarily cutting a bigger check to the U.S. Treasury.
 Buffett’s comeback is, and always has been, likewise straightforward: he simply follows the rules, he says, and the rules currently tax his earnings from dividends and capital gains at a lower rate than regular income.
 It’s the kind of by-the-book self-justification that drives those who see Buffett as a rank hypocrite out of their minds, and reassures those who see Buffett as a hero in the current policy wars.

 All this is unfortunate, because Warren Buffett, Political Guy had, until yesterday’s unprecedented share-repurchase announcement, largely wiped from the public mind Warren Buffett, Investment Guy—the supremely rational, highly quotable steward of Berkshire Hathaway whose track record for the last four-plus decades is, in fact, unequaled.
 How “unequaled” is Warren Buffett’s track record, you may ask? Well, he literally turned his own personal investment of $100—that’s one hundred dollars—into a current net worth of close to $40 billion (and $62 billion at its peak, before he started giving it away).
 To see exactly how he accomplished that unequaled feat, you can read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” (available at Amazon.com, here)which explains in plain English what made Buffett the Investor unique while also exploring the upsides and downsides of his extremely risk-averse management style...but we’ll provide one big clue here.
 That clue is the original “Buffett Rule,” quoted above, which had nothing to do with raising taxes on the wealthy and everything to do with investing, and is worth repeating:
“The first rule is not to lose.  The second rule is not to forget the first rule.”
 So well did Buffett adhere to this rule of investing that in his first 46 years managing Berkshire Hathaway’s investment portfolio, Buffett had exactly two losing years (the stock market had 11 in that time), thus allowing Berkshire’s net worth to compound at slightly over 20% a year—an astonishing rate of growth, never duplicated.
 But it is a track record that is increasingly underappreciated, because the old “Buffett Rule,” about investing, has been replaced by a new one, about taxing the rich.

The irony here, for anyone who has studied Berkshire Hathaway and Warren Buffett, of course, is that Buffett is as savvy in the taxpaying department as he is in the investing department.
 His recent, high profile $5 billion investment in Bank of America, for example, was structured to minimize taxes on the dividends Berkshire will receive (insurance companies can deduct a large portion of dividend income, unlike mere mortals).  This drives some bloggers crazy, but the fact is, Warren Buffett, as CEO of a publicly traded company, would be remiss if he did not attempt to maximize the after-tax benefits of all Berkshire’s activities.  Shareholders expect and deserve nothing less.
 Besides, Warren Buffett himself has always recognized the benefits of paying taxes at lower rates—via the same kind of low capital gains rates he currently criticizes.  Indeed, he long ago wrote to his own investors the following:
“I am an outspoken advocate of paying large amounts of income taxes – at low rates.”
—Warren E. Buffett, July 10, 1963
The quote is lifted, verbatim, from a letter Buffett wrote to investors in Buffett Partnership LTD (the hedge fund Buffett managed, prior to taking control of Berkshire Hathaway) and it was Buffett’s way of telling his investors that he would not make investment decisions based on the cost basis of stocks in the portfolio, but, rather “on the basis of the most probable compounding of after-tax net worth with minimum risk,” as he also wrote in that letter, which you can read here.
 (We’ve read all of Buffett’s early partnership letters, at least those available on that wonderful tool, the Internet, as well as every one of his Berkshire Hathaway letters, and advise any aspiring investor to do so as well.)
 Buffett thus early on identified the minimization of taxes as a key to maximizing long-term investment success, and knew the way to do that was to generate wealth through investments that were held long enough to be taxed at lower capital gains rates—a benefit “The Buffett Rule” would attempt to end—and anyone who has studied his methods knows this.

 Unfortunate as the uproar caused by Warren Buffett, Political Guy, has been by blotting out the accomplishments of Warren Buffett, Investment Guy, said uproar is especially unfortunate because it comes at a time when Warren Buffett, Investment Guy, has been busy on many productive fronts.
 The Bank of America investment—a no-lose deal in the classic Buffett vein—was just one front.  Another was his recent selection of a second investment manager, Ted Weschler, of whom we’ve heard nothing but good things (“a great, smart, smart guy” in the words of a former co-worker).  And a third front—yesterday’s share buyback announcement—is literally unprecedented in Buffett’s 46-plus years at the helm of Berkshire.
 But the most unfortunate aspect of all, in our view, is this: the original, no-nonsense, invaluable “Buffett Rule” has been replaced, in many investors’ minds, by a new, politically-oriented (and therefore vaporous) “Buffett Rule.”
 And that first Buffett Rule was one any investor, no matter what his or her politics might be, ought to have memorized.
 So much so we’ll repeat it here, for old time’s sake:
 “The first rule is not to lose.  The second rule is not to forget the first rule.”

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com

© 2011 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.

NOTE ON COMMENTS: We abide by one rule on the comment pages here, and that is NO “Yahoo Message Board-Type Language.”  So whatever you write and whether or not you agree or disagree with something, spell it correctly and keep it clean, and no personal stuff.  And if you think we won’t enforce that, well, we have over 300 comments that never appeared because they were sloppy, obscene, or personal. —The Management


Anonymous said...

I am surprised Buffett lets his NY Times Op-Ed be twisted so badly for political gain. Since most have probably forgotten his #1 rule from that piece:

"Job one for the 12 is to pare down some future promises that even a rich America can’t fulfill. Big money must be saved here."

Revenues were a distant second to entitlement reform, as anyone who understands our nation's long term fiscal picture already knows.

Anonymous said...

To clarify your comment on Buffett's 1963 letter, it should be placed in the context of the time. The top tax rate in 1963 was 90%.

see- http://elsa.berkeley.edu/~saez/course/Labortaxes/taxableincome/taxableincome_attach.pdf

Many high income people with ordinary income don't understand that the folks who make their income from long-term capital gains and dividend income do pay around 17% in US income tax.

Play with Turbotax, and it's easy to see that this is the case without Mr. Buffett needing to disclose his tax returns. To judge from today's Wall Street Journal editorial, the editors seems utterly incapable of grasping that unreasonably low tax rates exist for some people.

That said, while narrowing the gap in tax rates between short and long term gains rates by maybe 5% would add revenue, it doesn't solve the problems.

Thinking Out Loud said...

Is this Buffett's way to announce his retirement and get his company to buy back his own shares by private buy-back. What a wonderful unselfish way to prepare the path and gift his shareholders.

Jeff Matthews said...

Re: Thinking Out Loud's questioning whether Buffett is letting Berkshire buy in his own shares as a means of going private...the answer is, of course not! That would trigger capital gains taxes for Buffett. Better to avoid capital gains taxes (and inheritance taxes) altogether by gifting his shares to Bill Gates' foundation.

Re: Anonymous who points out the top marginal tax rate in 1963 was 90%... It was actually 91%, and the advantage of running a hedge fund, as Buffett did, was even bigger back then than it is now. Read "Secrets in Plain Sight."

Re: Anonymous who gripes that Buffett "lets his NY Times Op-Ed be twisted"... Buffett said flat out he'd raise taxes on the wealthy, and that nostrum has been incorporated by the President into what he called "The Buffett Rule." So blame the President, if you like.


Kyle said...

I'm about half way through reading your book. A pleasure to read entertainment and education wise. If you had to recommend a second biography on Buffett what would it be? As far as taxes are concerned I take the view that I don't like paying taxes but I'm thankful that I do. I like clean water, and relatively nice roads. I like turning on my GPS and having it work anywhere in the world. I'm pretty sure I'm not alone in those regards and countless others but it seems like a lot of people get furious every April 15th out of proportion to what they get in return. I really liked Elizabeth Warren's comments on paying taxes they seemed to strike the perfect balance between being a shareholder in society while still being able to enjoy the fruits of your labor. Any suggestions for a better tax system? I would like a flat tax and even though it's not in my interests capital gains brought in line with the income tax.

Jeff Matthews said...

Kyle: Thanks very much, glad you're enjoying the book. Roger Lowenstein's biography ("Making of An American Capitalist") is excellent. If you want a view of how Berkshire's various companies are managed (hint: without much interference, but without much capital) read Bob Miles' "The Warren Buffett CEO."
As for tax policy, a flat tax would be a boon to the country and American competitiveness by getting companies off corporate welfare and government out of the pay-to-play system of selective tax deductions. And if pigs could fly...

Again, thanks for reading.


The Steel General said...

Fact is, that countries with a normal taxrate on the wealthy are better able to take of their weakest members: Canada, Switzerland, Japan, 1950s1960s America.

You don't see shanty towns in those countries, like they are here.

Now, a nineteenth century kind of system, is perfectly workable and stable.
a welfare state is too: see Canada.

Personally, I don't wanna live in a neo-feudal society, but I guess that's up to those with the best propaganda machine, oops, i mean the voters, of course.

Americans will vote for Repubs everytime because a. they can't imagine a better life where wealht is more equally distributed, and b. Dems are not mean enough to fight them on it.

Until Americans stop believing that progressive taxation is fair, that taking care of the weakest should NOT be left to whimsical charities, but to the objective and rational government, nothing will change.
Oh and that the wealthy are job creators, instead of job exporters.

The Steel General said...

I'm curious. How would a flat tax get companies off corporate welfare?
WHAT corporate welfare?

And with Rick Perry's corporate cronyism, that wouldn't change a thing.

Bottom line: flat tax doesn't solve any problem, except for the rich.

I'm sure you don't want to get a Somalia type country.

Jeff Matthews said...

Steel General throws a lot of data points around, the biggest howler being an "objective and rational government." We won't get into the corruption scandals surrounding Medicare, Medicaid, DOE loan guarantees here, but suffice it to say the "objective and rational" label wouldn't fit any of those programs.

As for identifying specific acts of "corporate welfare," well, the sugar tariff, crop support programs and ethanol subsidies are the tip of the iceberg. A corporate and personal flat tax with no deductions, no subsidies, no nothing, is the idea. How anything else would be "fairer" is hard to fathom.



Anonymous said...

More duplicitous than the tax on earnings was Mr. Buffet’s public support of inheritance tax a few years ago, after setting up trusts to avoid it with his own wealth.

Anonymous said...
This comment has been removed by a blog administrator.
Anonymous said...
This comment has been removed by a blog administrator.
Jeff Matthews said...

We're getting a LARGE number of URGENT comments with VERY political/uninformed statements accent with important stuff IN CAPS. Whether from the LEFT or the RIGHT we have no interest in turning this comment section into a Yahoo message board, so post 'em on Fox or MSNBC please.

And when you do comment, be specific and, preferably, cite facts whenever possible.


Anonymous said...

Well, JM, what goes for the goose, should go for the gander, innit?

Please do qualify your statement that "a flat tax would be a boon to the country and American competitiveness"

As for my statements on income inequality, for I do hope you got that they were about that see here:
Yes, it's wikipedia, and they are well sourced article.

Anyhow, the statement that the income inequality in the US is larger than that of the Canada/Europe should not come as a surprise.

One of the biggest contributors to a worsening income inequality would be your flat tax.

In short, what you propose is this: After giving the wealthy everything they wanted, for 30 years, you want to give them an even bigger piece of the pie, right? 30 years ago, shoveling money towards the wealthy had never been really tried, so they had some reason to make us believe that if the rich got richer, we'd all benefit. Not no more.
The average F500 CEO used to make 75 times Joe Sixpack, now that is about 450 times good ol Joe. I refer you to the NYT article, which has excellent links to Forbes.

Anyway, I somehow don't think you're capable of ingesting that information, if you cavalierly propose a flat tax as a "boon".

Anonymous said...

I've noticed that in your mentioning of examples of governmental wrongdoings, the two Repub-started wars in Iraq and Afghanistan are conspicuously absent.

To remind you: these were wars which weren't paid for and which he kept OFF the books, so he wouldn't look so bad ...
A clearer example of governmental misdeed can't be found.

Or, it must be the torture in Gitmo, the Patriot Act.

If you want this blog to be "fair and balanced" and not some Yahoo message board, you should at least have mentioned some of those.

And, why are leftwing causes labeled "political" and right wing fancies not?

I think you honestly believe that stuff like advocating for a flat tax is decidely NOT political, but some natural order thing. Am I right?

Do you really believe that all progressive causes are "controversial", "activist" and therefor irrelevant?
I'm just curious about middle class people like yourself proposing to give even more money to the rich, when that clearly hasn't worked.

Jeff Matthews said...

Anonymous would be wise to switch to decaf. We posted these last comments to show what readers are missing. Unlike the writer, we have no ax to grind against left versus right, or right versus left, and in fact never discussed parties in this post, or left vs right and vice versa, for that matter.

As for why a flat tax would be a productivity boon, fact one is the efficiency cost of the tax system (as per the GAO) is $240B-$600B (that's the cost of the ridiculous, loophole-ridden system a flat tax would replace); fact two is that the US corporate tax rate is second highest, behind Japan...and if you don't think corporate tax rates drive investment, you haven't noticed the loss of 6mm jobs to other countries during the so-called economic recovery of 2009-2010.

Which brings us to the subject of jobs and job loss: we're hearing about recent, specific layoffs at various firms (for example, 150 people at a New York State electronics firm). We'd be interested in hearing other examples of what may, unfortunately, be a trend in the making.


Anonymous said...

A different Anonymous here:

A quote that I'd love to have more information on:
"fact two is that the US corporate tax rate is second highest, behind Japan..."

Well, yes. And the highest income tax is well above 20%, yet the top 400 earners pay less than 20% on their incomes, for reasons already mentioned.

So a fairer statement would be how much do American corporation REALLY pay in income tax relative to other countries? Considering tax loop holes and corporate welfare mentioned, I suspect (but do not know for a fact), that the relative rankings will be different once all that stuff is taken into account. And of course, that would mean taking into account similar accounting tricks and corporate welfare shenanigans present in other countries.

Anonymous said...

On the one hand, I don't want to begrudge Buffet's being ready, willing and able to get Berkshire Hathaway great deals that have government backing (e.g., the Goldman Sachs preferred deal).

Also, if he wants to express his views on taxes, and admiration for Bernanke, Hank Paulson, Tim Geithner, etc. -- the Bailout Engineers I'll call them -- well, fair enough.

I should say that I unequivocally disagree with Buffett about what happened in the lead-up, during and in the aftermath of the bailout. I think it was a great crime against the American people. Regardless of how one feels about the necessity of the bailouts, they did not have to be engineered in a way that was so kind to the culprits.

But what I think folks need to realize when Buffett speaks on these matters is that he has an awful lot of skin in the game and it seems to me like all of these bailout measures and deals came out his way.

And, again, this is America, so if a guy wants to work the system, well, I guess that's the way it's always been. Crying about how unfair it is -- even if it is unfair -- won't get the cry baby anywhere.

But I think that people really ought to consider that Buffett's motives aren't so pure when he waxes political. Like maybe he's an "Operator" just like others who don't garner even a fraction of the trust or respect that he does.

Maybe Buffett has just been talking his book all these years, with some fair-sounding tax talk thrown in to keep the folksy image going.

In other words, while maybe it's wrong to judge Buffett for what he has said and done, maybe we should take a harsher assessment of how much trust we've put into his political and economic advice (not talking about investment advice).

Anyway, I realize that this comment is factless. Just wanted to get my two cents in.

Jeff Matthews said...

Regarding how much US corporation "REALLY" pay as an effective tax rate, not just theoretical, there's a lot of data around on just that topic, and you can find it online. It's higher than for their peers

Suffice it to say companies wouldn't move to Ireland or Switzerland or Bermuda otherwise.


Anonymous said...

I don't think you can find any credible sources for your statement that a the usa has the highest corporate tax rate after Japan.
otoh, you still haven't responded to the statements about income inequality being far worse in the usa, which are too, well sourced.

Assigning a single explanation to any phenomenon is always foolish, as you do with saying that corp. taxes causes job losses.
Especially when there such clear examples where high taxes aren't "causing" joblosses, like Germany, NW-Europe, Canada.
It shows your ignorance about anything outside the US.

Maybe you should lay off the Kool-Aid?
And if you're so independent, I'd like to hear which progressive policy, you support.

Jeff Matthews said...

Start with the following. Then give us your data as we're still waiting for it.



Don said...

Does Warren pay any taxes at all, other than FICA on his salary? I would think that, given the scale of his charitable donations, his tax rate would be 0%.

So of course his secretary pays a higher rate... or am I missing something?

Jeff Matthews said...

Don asks a very good question.

For the answer, understand that you have to listen to (or read) what Buffett actually says, because (and this is what makes him worth listening to when he talks about investing, because he listens to questions and answers them very specifically) Buffett is precise about language.

So in the case of his "I pay less tax than my secretary" argument, what he actually says is some form of "I pay a lower tax rate" than his secretary--the "rate" being the key.

For example, in 2007 he told a Hillary Clinton fundraiser he was taxed at 17.7% on the $46 million he'd made in 2006, while his secretary, who made $60,000, was taxed at 30%. He did not talk about taxes net of deductions, or the effective rate net of deductions.

In short, what Buffett is talking about is the rate at which his income is taxed, and because it mainly comes from dividends and capital gains, it's a lower rate than his secretary, even if it turns out he actually pays no tax at all given his charitable deductions.

Keep those cards and letters coming.


Jeff Matthews said...

We're getting a lot of Yahoo Message-Board style comments that will not be published. Clean up the language and clean up the thought process. Leave your politics at home--or, better yet, take it to the message boards.