Monday, August 15, 2011

The Buffett Op-Ed

Others have already tackled this Op-Ed by Warren Buffett, in which he basically calls for higher capital taxes. Buffett's argument revolves around fairness -- he doesn' t seem to be taxed very much on a personal basis relative to the administrative staff in his office (why he continues to have administrative staff is another story -- one imagines that he could just learn to use Google Calendar, email, and then fire everyone else). The take on the other side is that we ought to set taxes on capital and corporations in ways that make sense for society as a whole, not for reasons of fairness.

And Buffett is absolutely playing this for personal PR purposes -- the more he ostensibly calls for greater "sacrifices" from himself; the more he alleviates any potential sources of envy against his wealth. Buffett may well end up doing better in a world of higher capital taxes, which would place enormous burdens on his competitors. Add to that his own ideological biases, the fact that Buffett doesn't pay many taxes anyway due to the fact that he's donating the vast bulk of his wealth, etc. and you end up with a not-particularly compelling case.

But then you also have some seemingly factual howlers.

Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

This doesn't seem right at all. I'm sympathetic to eliminating carried interest rules; but it just seems wrong as a factual matter to argue that short-term investment gains are taxed at the long-run rate for those institutions -- or so I glean from Avik Roy. See the new update.

Then there's this section, which is something that Buffett repeats over and over:

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

Leave aside Buffett's estimation of his own tax liability, which primarily reflects capital gains. How are his other office employees taxed at those rates? After all, one only enters the 35% income tax bracket after $250,000; and even there the average tax liability of a person will be much lower (something like 27% in my calculation). Is his comparing his average tax liability with the marginal tax liability of his employees? In the past, he's frequently claimed to have a higher tax rate than his secretary making $60,000 a year. Yet the marginal tax rate for a single person with that income is 25%. That's of course higher than the 17% he quotes above; but is far lower than the range he provides there (with an average tax liability that is far lower too).

There's much more here that's absurd. For instance:
I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off.
Why don't we just go all the way up to a tax rate of 90% then if the tax rate doesn't matter? If you think it matters at 90% on some margin, who is to say it doesn't matter at 39.9%? Why on earth do we think that asking investors will yield better information than thinking through data or theory? There's just no reason to think that making lots of money endows someone with insight in public policy or a comparative advantage in Op-Ed writing.

Update: From James Choi, someone with an Adjustable Gross Income of ~$60,000 pays 12.9% of their taxable income as income tax, and 8.5% of their AGI as income tax. Sure, you can add in payroll taxes, etc. in here -- but it's difficult to see exactly where he's getting the "my secretary pays so much more in taxes than me" statistics from.

Update 2: Steve Waldman has more in the comments regarding the tax treatment of futures. Buffett was right about this and I was wrong. It's still somewhat misleading in the sense that it presents an extreme example of short-term trading, when only 10 percent of the gains accrued by partners are taxed overall at the short-term rate. The particular rule behind the mentioned 60/40 split seems reasonable. Buffett's real concern anyway is not with the long/short run taxation of capital; but with carried interest rules and capital taxes generally. And I'm somewhat with him on the carried interest rules.


Steve Randy Waldman said...

arpit - no time to comment broadly, but as a factual matter WB is right on the tax treatment of futures. they are treated specially, i'm guessing because holding period tells little about economic risk-bearing since futs investors "roll" short-term holdings to synthesize long-term positions. regardless of holding period, futs proceeds are taxed partially as LT, partially as ST, gains. (i trade futs and benefit from this. i'm commenting from my phone and unreliable from memory, but look up sec 1254 contracts and i think the split is 60:40.)

Arpit Gupta said...

Thanks for commenting -- I'm judging from Avik Roy's thoughts. What I got from that was that fund capital gains are treated as gains to the managers, and taxed as capital gains at the relevant rate. This does seem to be roughly what I read elsewhere. I am very sympathetic to the argument that this *should* be treated as wage income, even if that requires ad hoc regulations against certain investment vehicles to preserve the concept of sweat equity.

I see two ways to read your counter -- that certain transactions split long/short term rates regardless of duration, or that it is possible to synethesize a long-run contract to replicate any short term trade. The second point seems right to me. Instead of selling a share to book a short term profit, it seems that one could open a second short and hold both positions over time. But I don't see support for the idea that futures trades regardless of duration are taxed at a mix of long/run short run rates. But I could very well be wrong.

Steve Randy Waldman said...

Arpit -- There are two distinct issues. I've been arguing with Avik re carried interest over Twitter, but that's a different thing for the 60/40 LT/ST split on futures trades.

As an individual futures trader, with no partnership interest, "sweat equity", whatever, involved, futures trades get reported specially, and gains are automatically taxed at a mixed short-term/long-term rate. I don't think Avik and I will disagree on this one; it's just a fact of US tax law. (It's on my mind, because i've been misreporting futures trades under Schedule D, and have been working with accountants to amend my returns.)

The justification for the mixed treatment of futures is straightforward. Suppose I want to own the S&P 500 via futures. I buy a three-month futures contract. After two months, I sell that contract and replace it with a new, three-month forward contract. I do that over a period of 5 years. Economically, my risk position is (almost) equivalent to owning the S&P basket of stocks for 5 years. But I have never held any one contract for more than 3 months! Short-term tax treatment seems wrong. Applying long-term capgains to a 3-month contract also seems wrong. The IRS could ask traders to prove that they are rolling positions forward to substantially maintain economic exposure if they want LTCG rate, but that would be cumbersome and vulnerable to a variety of manipulations e.g. to defer gains. So, they've adopted a simple rule: they assume futures traders are 60% rolling long-term positions and 40% trading short-term positions. See e.g. (btw, it is sec 1256 contracts, not 1254 as i wrote above. sorry!)

Arpit Gupta said...

Got it - updated the post to reflect that. Always happy to learn new things.

That twitter exchange is interesting too -- I'd be interested to see your thoughts on this at greater depth. Your position seems pretty reasonable.