Warren Buffet is simply wrong.

| August 15 2011
Christopher Cook

How is it that someone as smart and successful as Warren Buffet could be so wrong on his interpretation of tax policy? Truly, it is an example of how intelligence and success are not guarantors of wisdom, nor are they guarantors that any one person will correctly interpret given fact sets. And in his recent New York Times opinion piece Stop Coddling the Super-Rich, Warren Buffet makes it clear that he is much better at making money than he is at understanding taxes policy.

His overall argument is that the rich aren’t paying enough in taxes:

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.

So he’s saying here that the super-rich pay less in taxes that the sorta-kinda rich. Fine, that is true, largely because the super-rich aren’t making their money as much from income as the sorta-kinda rich. And certainly as you move down the line into middle class brackets, that effect is exacerbated. So far so good.

But then he makes error number one: pretending he’s an economic analyst rather than an investment guru. Here is a summary of his errors, and what we will cover in this piece:

Buffet’s first point is that the rich are undertaxed, and that taxing them more won’t negatively impact growth. He has no evidence for that, and his shallow analysis is entirely unconvincing.

Buffet’s tacit assertion is that if the rich were taxed at higher rates, it would bring in more revenue. He has no evidence for that. In fact, historical data show no such correlation.

Buffet’s fundamental point is that if the rich were taxed at higher rates, the (supposed) higher revenue would help improve our economic and debt situation. About that, he is flat-out wrong.

Drasically, seriously, tragically wrong.

Part 1

Essentially, he tries to assert that tax rates do not affect economic growth:

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. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

Anecdotal stories from his super-rich friends . . . and a very surface observation about job creation by decade, without reference to any details on what happened in the economic cycle during those decades. Impressive!

Me . . . I prefer real data to superficial observations. This is from page 27 of the Organisation for Economic Co-operation and Development’s (OECD) ECONOMICS DEPARTMENT WORKING PAPER NO.620, by Åsa Johansson, Christopher Heady, Jens Arnold, Bert Brys and Laura Vartia. (Note: The foregoing refers to income taxes, not capital gains taxes, but is pertinent to Buffet’s overall point, and a subsequent point he makes on income taxes, q.v.):

65.    Top marginal statutory rates on labour income have an ambiguous impact on TFP via entrepreneurship by affecting risk taking by individuals. On the one hand, high top statutory income taxes reduce the post-tax income of a successful entrepreneur relative to an unsuccessful one and can reduce entrepreneurial activity and TFP growth. On the other hand, high tax rates provide for increased risk- sharing with the government if potential losses can be written off against other income (tax payments), which may encourage entrepreneurial activity (Myles, 2008). However, Gentry and Hubbard (2000) suggests that the higher is the difference between the marginal tax rates when successful and unsuccessful (a measure of tax progressivity) the lower is risk-taking as the extra tax that applies to high profits is greater than the tax saving that is produced by losses, effectively reducing the strength of the risk-sharing effect.

66.    Industry-level evidence covering a sub-set of OECD countries suggests that there is a negative relationship between top marginal personal income tax rates and the long-run level of TFP (see Box 4 for details). The magnitude of the estimated impact of a change in top personal income taxes differs across countries depending on the composition of their business sectors, increasing with the proportion of industries with structurally high entry rates. One possible policy implication may be that countries with a large share of their industries characterised by high firm entry (or wishing to move in this direction) may gain more from lowering their top marginal tax rate than other countries. However, it is likely that some other policies and institutional settings, such as product market regulation, have a more direct impact on entrepreneurship (Scarpetta and Tressel, 2002; Brandt, 2005; Conway et al. 2006). Additionally, the magnitude of the impact of tax reform may depend on the stance of these policies. Indeed the empirical analysis shows that the negative impact of top marginal tax rates on TFP is stronger in countries with a high level of the OECD indicator of product market regulation (PMR)25, suggesting complementarities between taxation and product market policies.26

Okay, I admit that that section is pretty heavy going. But it is possible to read it and understand the overall point. The results of this study and scores of studies like it indicate that increases in the top marginal rate do have a negative impact on GDP and productivity. Did Buffet read this study, or any portion of it? I doubt it. If he had, he probably might have thought twice before issuing yet another set of Democratic Party talking points masquerading as serious analysis.

If he had read it, he might have at least gotten as far as the abstract:

This paper investigates the design of tax structures to promote economic growth. It suggests a “tax and growth” ranking of taxes, confirming results from earlier literature but providing a more detailed disaggregation of taxes. Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes. Recurrent taxes on immovable property appear to have the least impact. A revenue neutral growth-oriented tax reform would, therefore, be to shift part of the revenue base from income taxes to less distortive taxes such as recurrent taxes on immovable property or consumption. The paper breaks new ground by using data on industrial sectors and individual firms to show how re- designing taxation within each of the broad tax categories could in some cases ensure sizeable efficiency gains. For example, reduced rates of corporate tax for small firms do not seem to enhance growth, and high top marginal rates of personal income tax can reduce productivity growth by reducing entrepreneurial activity. While the paper focuses on how taxes affect growth, it recognises that practical tax reform requires a balance between the aims of efficiency, equity, simplicity and revenue raising.

“Corporate taxes are found to be most harmful for growth, followed by personal income taxes . . .”

” . . . high top marginal rates of personal income tax can reduce productivity growth by reducing entrepreneurial activity . . .”

But, hey, what is a massive, multi-country, academic OECD study in the face of The Sage of Omaha’s opinion?

Buffet and his crowd (the left, not the super-rich) love to try to make this argument that lower taxes do not produce growth. Recall, from above:

You know what’s happened since then: lower tax rates and far lower job creation.

This requires more that we have time for here. For now, a few quick points.

  • The 1980s did see a massive reduction in taxes, and a massive increase in growth. Correlation is not necessarily causation, but there it is.
  • What I can tell you for sure is that higher tax rates in the 1990s did not cause the economic boom of that decade. Read Smarts are not enough: Part 2 for details.
  • The economic story of the 2000s is one of . . .
    • a small post-boom recession, followed by
    • the massive economic hit of the 9/11 attacks, followed by
    • a rapid and solid recovery after the Bush-era tax cuts were passed, followed by
    • the start of arguably the worst economic downturn since the 1930s, which was the result of a complex set of factors going back decades.

At this juncture, I won’t even assert that correlation is causation with the Bush-era tax cuts. What I will tell you is that Buffet’s “analysis” is shallow and not very sophisticated. “More jobs were created in one decade than another, and tax rates don’t play a role because I say so, so nanny nanny boo boo.” Things are a bit more complex than that.

Excessive regulation and uncertainty—including uncertainty about tax policy—also play a role in whether investments will be robust and jobs will be created. Even the OECD study has something to say on regulation:

However, it is likely that some other policies and institutional settings, such as product market regulation, have a more direct impact on entrepreneurship (Scarpetta and Tressel, 2002; Brandt, 2005; Conway et al. 2006).

Bottom line:

The OECD study and other data indicate that tax rates impact growth. Buffet’s assertions in this regard are based on shallow analysis. They also ignore the impacts of regulation and uncertainty.


Part 2

Buffet’s problem gets worse from there. Clearly his overall point is not just that the super-rich do not pay enough in taxes; it is, rather, that the  super-rich do not pay enough in taxes, and if they did, it would produce more revenue (and presumably help solve our problems).

Where is his evidence for that? Where are his data?

Oh look, here are some data:

http://www.heritage.org/budgetchartbook/charts/2011/income-tax-receipts-600.jpg

No matter what the top rate, it appears that revenue doesn’t change much. People change their behavior to react to changes in tax policy. Rates go down and investments may go up, thus accounting for the stability. Small fluctuations may be attributable more to business cycles, but large fluctuations are clearly nonexistent.

So how is it that Buffet thinks taxing the rich more is going to help anything? Indeed, as tax rates have been falling, revenues have been rising:

http://www.heritage.org/budgetchartbook/charts/2011/federal-government-revenues-600.jpg

Even now—for the time being at least—I am not making the blanket assertion that correlation is causation—that lower tax rates are responsible for revenue increases. What I am saying—and get ready for bold and all caps—is this:

BUFFET PROVIDES NO EVIDENCE THAT HIGHER TAX RATES WILL BRING IN MORE REVENUE. NONE.

The reason he provides no such evidence is that such evidence is very hard to come by. Very hard.

So why make the suggestion at all? If higher tax rates won’t bring in more revenue, what good will they do?

 

Part 3

Buffet’s problems get even worse. He says:

Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2 percent on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion — a staggering $227.4 million on average — but the rate paid had fallen to 21.5 percent.

Okay, so let’s just do some static analysis here. We won’t try to do the hard work of dynamic analysis, where we take into account how changes in tax rates will alter behavior of people and markets. We’ll just take the straight numbers as he provides them.

$90.9 billion
taxed at 21.5 percent
produces $19.5 billion in revenue.

$19.5 billion
divided by $4.7 billion (the amount of money the U.S. government is borrowing every single day)
gets you 4.1 days of borrowing covered.

Buffet is right—that’s clearly not enough. So let’s tax those richers at 50%. That’s will cover 9.7 days of borrowing. Wow, we’re over a week!

Not enough? Let’s tax ‘em at 100%. Ignore the fact that people taxed at 100% will quickly stop working altogether. Let’s take the whole $90.9 billion. That gets us 19 days!

We do not have a revenue problem. We have a spending problem. You can also argue that we have a growth problem, but how is raising taxes going to fix that? Buffet’s argument is that we need to tax the rich more, and that doing so won’t impact growth. Even if that were true, it also would not be enough to put even a small dent in spending. There simply aren’t enough rich people to cover these levels of spending.

Even if we expand beyond the group Buffet mentions above—those uber-rich top 400—there still aren’t enough. In Taxing or taking from the rich won’t fix the problem, Part 1, Part 2, Part 3, and Part 4, we show that you could tax all the rich people in the country at massive rates, and we would not have enough money to even dent our deficits and mounting debt. As the video at the end of this piece shows, so brilliantly, forget taxation . . .

 . . . even if we confiscated every bit if wealth the rich have, there STILL isn’t enough money. We are simply spending more than any economy can handle.


Conclusion/recap:

Buffet’s first point is that the rich are undertaxed, and that taxing them more won’t negatively impact growth. He has no evidence for that, and his shallow analysis is entirely unconvincing.

Buffet’s tacit assertion is that if the rich were taxed at higher rates, it would bring in more revenue. He has no evidence for that. In fact, historical evidence shows no such correlation.

Buffet’s fundamental point is that if the rich were taxed at higher rates, the (supposed) higher revenue would help improve our economic and debt situation. About that, he is flat-out wrong.

Honestly, I don’t quite get why they call him the Sage of Omaha.

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