Warren Buffett faces a 90% plus tax rate

I actually don’t know the exact tax rate, but from what I can tell it’s probably well in excess of 90%.  Unfortunately, Warren Buffett seems to know little or nothing about tax theory, and hence has been arguing that his tax rate is equal to the amount of tax paid, divided by his income.  As I argued here, income is a nearly meaningless concept in economics.  All tax incidence questions need to be addressed in terms of consumption.  I don’t know how much Buffett consumes each year, but this article suggests the amount is rather low:

Warren Buffett, perennially ranked among the world’s richest men, lives a lifestyle that hasn’t changed much since before he before he made his billions. He is often referred to as the world’s greatest investor, and his long-term track record suggests the title is well deserved. He is also legendarily frugal, residing in the same house in Omaha, Nebraska, that he bought in 1958 for $31,500. He is well known for his simple tastes, including McDonald’s hamburgers and cherry Coke, and his disdain for technology, including computers and luxury cars. Underlying his legend is one simple fact: Buffett is a value investor. It’s the hallmark trait of both his professional and personal success.

Let’s assume his consumption is less than $600,000.  In this op ed he says he paid nearly $7,000,000 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.

There are so many things wrong with that statement that I hardly know where to begin.  The tax rate he cites is probably a rate on investment income.  But the tax rate on investment income should be zero–only consumption should be taxed.  His taxes paid are probably over 90% of taxes plus consumption.  Even worse, taxes on capital income represent double taxation, as the money was first taxed as labor income, and then taxed again as capital income.  He ignores that problem; perhaps he’s not even aware of it.  He also confuses nominal and real tax rates.  In the US the tax on investment income applies to nominal earnings; the tax rate on real earnings is far higher–over 100% for many Treasury securities.  And as Greg Mankiw points out he ignores that fact that much of his earnings were taxed at the corporate level.

Warren Buffett should be paying far less in taxes, perhaps less than me.  The people who should be paying lots more in taxes are the billionaires with their 400 foot yachts, mansions, and fancy parties.  I’m sure if they tried to do that the bill would be filibustered by liberal democratic congressmen from NYC.  Much of Manhattan’s economy is providing luxurious goods and services to the rich.  Don’t believe me?  Then read this link.  Dems say they want “fairness,” but oppose the only way to make the tax system fairer–higher taxes on wealthy lifestyles.

Many people find tax theory counter-intuitive, so think of it this way:

1.  Buffett’s consumption is the resources he takes out of the economy for his own personal enjoyment.

2.  Taxes paid are what he contributes to the common good.

It’s very possible that the wealthy should be paying far more taxes.  But Buffett should be paying far less than he currently pays.


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73 Responses to “Warren Buffett faces a 90% plus tax rate”

  1. Gravatar of Jon Stokes Jon Stokes
    9. September 2011 at 15:54

    Maybe I’m confused (and I did go back and read your tax post), but are you assuming here that Buffett derives utility only from money that he spends for his personal enjoyment, and that he derives no utility from income and wealth that he does not spend?

  2. Gravatar of W. Peden W. Peden
    9. September 2011 at 16:43

    Correct me if I’m wrong, but isn’t it possible to voluntarily be taxed more than one owes to the taxman? If I wanted to leave my entire estate to the state, would the Inland Revenue stop me?

  3. Gravatar of Bryan Willman Bryan Willman
    9. September 2011 at 17:36

    Given that the % of the population required to produce “bare essentials” everybody needs is falling, will we not soon a face a need to have everybody consume a lot of luxuries in order to have anything like full employment?

    For example, if all “rich people” stop buying boats because doing so hits them with a “consumption tax”, what will we do with the unemployed boat industry?

    Given that there can be “more money to invest than worthy things to invest in” (bubbles), we are we sure that huge investment rates are a good a thing?

    And of course “tax the rich” is at least partly about class warfare, and “only tax consumption above some level” probably won’t serve that purpose very well.

  4. Gravatar of Morgan Warstler Morgan Warstler
    9. September 2011 at 17:43

    No wait.

    Consumption under consumption tax MEANS:

    *Every jet ride
    *Personal security
    *Hotel rooms
    *Gifts

    Under a consumption tax is that you zero out all corporate expenses, past lowest common denominator.

    And then whichever entity pays a higher rate, that’s how you eat it.

    Progressive Consumption Tax = there’s no way to consume anything without paying the highest possible tax on all things consumed by you.

    Properly done a consumption tax ends corporate expense accounts, because most every executive WOULD RATHER have the higher salary and keep the cash.

  5. Gravatar of Benjamin Cole Benjamin Cole
    9. September 2011 at 17:56

    Interesting post by Scott Sumner. I agree with it. I have always favored consumption taxes, and PIGOU taxes. And taxes on rap music and Paris Hilton “news” stories.

  6. Gravatar of Scott Sumner Scott Sumner
    9. September 2011 at 17:59

    Jon, No, I assume he gets satisfaction from the billions he donates to the Gates Foundation. But that satisfaction should play no role in public policy. It can’t be measured–only consumption can be measured.

    W. Peden, Yes, and many people have asked him that.

    Bryan, Americans already consume lots of luxuries. I don’t have a cell phone–that’s a luxury. So are laptops and iPods, which I also lack. There’ll be plenty to produce.

    A consumption tax doesn’t encourage too much investment–it merely refrains from discouraging investment.

    Morgan, If you are saying that things like business lunches should be taxed–I agree.

  7. Gravatar of ChacoKevy ChacoKevy
    9. September 2011 at 19:09

    I don’t know what Buffett’s reasons are for not individually contributing to the IRS, but if I had a kajillion bucks, here is why I wouldn’t either: the wars. I would never send an extra penny to help bankroll operation enduring quagmire individually, but if we, as a nation, decide it is worth it, and reflect that commitment in our taxation, then I would quietly comply.
    My question, then, is on the expenditure side. If a governor went on record that they didn’t want ARRA cash but didn’t refuse it after passage, aren’t they in the same predicament as Buffett on the expenditure side?
    To spend is to tax, right?

  8. Gravatar of Sean DeCoursey Sean DeCoursey
    9. September 2011 at 22:44

    “Even worse, taxes on capital income represent double taxation, as the money was first taxed as labor income, and then taxed again as capital income.”
    -
    Scott, I’ve seen that argument made several times in a variety of places and it’s always struck me as incredibly fallacious. The government isn’t really taxing income, it’s taxing individuals and using income (or capital income, or income of any kind) as a basis for deciding how much to tax that individual.
    The point isn’t that “the money” has been taxed multiple times, it’s that every time it goes to a new person the government gets a cut for providing the service of an economy and financial system and banking system and money instruments etc. where that transfer can take place.
    Honestly, if you want to make the argument that the money/income has been taxed twice, it applies as equally to payroll tax, sales tax and property tax as it does to capital income tax.
    If I’m missing something terribly obvious here, please feel free to enlighten me.

  9. Gravatar of KRG KRG
    9. September 2011 at 22:51

    I don’t quite get why consumption- the primary driver of employment- should be what gets taxed. If anything, if should be what’s tax exempt, with the leftovers- the stuff that gets dumped into loans and stock speculation- being what’s taxed, since does more harm than good in large quantities.

    A business can operate without financial investments so long as it has sufficient revenue to do so. A business without any expected revenue on the other hand, in a remotely rational world, should not last long, no matter how many loans that it can manage to finagle. Consumption taxes are the ultimate in perverse incentives, encouraging loans over the direct payments and purchases that comprise revenue, thus consuming labor (creating jobs) to produce the things being purchased.

    It’s also absurd to suggest that money that goes through two separate transactions- corporate profits to personal profits is double taxed. Each transaction is distinct; if the corporation did not want the money to be taxed, it should instead have spent it on some form of deductible capital rather than reserving it as profits until its profit margin was tight enough to be within a minimally taxed range, creating returns to investors spread across a longer, more sustainable period, rather than quickly and at the expense of potential expansion.

  10. Gravatar of Gene Callahan Gene Callahan
    10. September 2011 at 00:10

    “It’s also absurd to suggest that money that goes through two separate transactions- corporate profits to personal profits is double taxed… if the corporation did not want the money to be taxed, it should instead have spent it on some form of deductible capital…”

    So, wait: it’s absurd to suggest there is double taxation because one of the two times could have been avoided? That is in fact a *recognition* that double taxation is going on!

  11. Gravatar of Wadolowski Wadolowski
    10. September 2011 at 00:44

    Prof. Sumner I just want to say: You’re so right!

    By writing this post you fully express my point of view on taxing. I just could not stop myself from leaving this comment.

    Why don’t we see more of this kind of thinking. Why to punish anybody for investing? But it think it would be very hard to construct this kind of tax code, that would give relevant amount of revenues and be hard to avoid as well.

    But it’s worth trying.

    The are so many examples of consumption that it’s so obvious to “punish” with taxes:

    -alcohol
    -gasoline
    -cigarets
    -jets flying
    -gold
    -jelvery
    -large houses
    -expensive cars
    an so on, so on…

    I don’t understand why the idea isn’t more widespread among the decisive people…

  12. Gravatar of beowulf beowulf
    10. September 2011 at 00:50

    I’m with William Vickrey (and Sarah Palin!) that corporations shouldn’t be taxed at the entity level. Treat them like REITs, No entity taxation if at least 90% of earnings pass through as dividends (taxed at ordinary income rates).
    At which point, any corporation that held earnings offshore or that overpaid its CEO would be seen as cheating their shareholders instead of the IRS.

  13. Gravatar of sanchk sanchk
    10. September 2011 at 01:41

    Hmm… that age old (or at least the recently surfaced question) of whether to tax wealth, or flows.

    It reminds me of a puzzle posted by Steven Landsburg a few months ago:

    “Stevens wants to tax the “idle rich”, her Exhibit A being Robert Kendrick, heir to the $84 million Schlage Lock Company fortune. According to Ms. Stevens, Mr. Kendrick appears to do pretty much nothing but park and re-park his four cars all day long. Taxing people like Mr. Kendrick, she says, has to be part of any solution to America’s fiscal crisis.

    Here’s what Ms. Stevens misses: Assuming the facts are as she states them, it is quite literally impossible to raise revenue by taxing the likes of Mr. Kendrick. We could argue about whether it’s desirable, but because it’s impossible, the discussion is moot.

    Here’s why it’s impossible: For the government to consume more goods and services, somebody else must consume fewer. But Mr. Kendrick, by Ms. Stevens’s account, consumes almost no goods or services whatsoever. He just pushes cars around all day. His consumption can’t go much lower.”

    The only way I can think of taxing Mr. Kendrick is through an inheritance tax. But, as you say, the best sort of tax is that which transfers resources which individuals would spend on personal ‘lavishes’, to the government to spend on beneficial programs for society. That tax model however would be completely unfeasible in Congress.

  14. Gravatar of Phil Sprunger Phil Sprunger
    10. September 2011 at 04:43

    @peden and @Scott Sumner: isn’t it a weak argument to say that someone who calls for higher taxation should just volunteer to pay more in taxes? Yes, of course you can do that, but doing so is very different than calling for people to be compelled to do so. If it is a good argument, then any person who calls for higher defense spending should just donate to the Pentagon instead or anyone who wants calls for a local bond issue to remodel a crumbling school should be just as happy to donate money to the school as to attempt to get everyone taxed. There are plenty of ways to counter Buffet’s position (such as efficiency of corporate taxation or appropriate levels of expenditure or public debt), but this is not one of them.

  15. Gravatar of Floccina Floccina
    10. September 2011 at 04:54

    I do not know for sure but I bet that Warren Buffett pays much more in taxes than he spends on consumption.

  16. Gravatar of Floccina Floccina
    10. September 2011 at 04:58

    Sorry for the post above, you already said that.

  17. Gravatar of rick rick
    10. September 2011 at 05:26

    I’m in need of a brief on why we should not tax investment income, especially hedge funds.

    Isn’t my intellectual capital as a surgeon as valuable to society as making a long/short bet on the relationship between Exxon & BP after the oil spill? And yet I’m taxed more than a 2 & 20% quant that may blow up a bank, ala LTCM?

  18. Gravatar of W. Peden W. Peden
    10. September 2011 at 05:47

    Phil Sprunger,

    “Yes, of course you can do that (pay more taxes), but doing so is very different than calling for people to be compelled to do so.”

    That’s exactly the point. If all Warren Buffet is saying is that he wants to contribute more, then no-one is stopping him. If Warren Buffet is calling for the rich to be taxed more, he has to give a better argument than “I wouldn’t mind it”. My preferences are a really important part of my decision making. Other people’s? Not so much.

    All that my pithy rhetort was intended to do was to make it apparent that Warren Buffett isn’t actually making an argument for anything. He’s just making a statement of his preferences and a logically separate imperative for the rich to be taxed more.

    I say all this as someone who wouldn’t mind a higher tax rate for the rich (though like Scott Sumner I’d rather see them taxed more on consumption than income).

  19. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 05:58

    ChacoKevy, Good point.

    Sean you are flat out wrong. Read the first post I link to–it explains why consumption should be taxed, not income. Taxing income is both unfair and inefficient. It’s unfair because high savers get taxed at much higher rates that low savers with equal lifetime resources. And it’s inefficient because it discourages saving and economic growth.

    My views aren’t at all controversial within economics-it’s the standard model. Even Matt Yglesias says we should tax consumption, not income.

    KRG, You are completely wrong. Corporate income is actually triple taxed, other investment income is doubled taxed. Consumption doesn’t create more jobs than investment. Production of either type of good (consumption or investment) creates jobs. Read my first link above.

    Wadolowski, Thanks, but I don’t agree with your list. I would tax all consumption goods equally, except those with negative externalities like high carbon emitting goods. I would tax those people with high levels of consumption at higher rates.

    beowolf, I wouldn’t even tax the investment income at the point it reached the individual.

    sanchk, Yes, I did a similar post to Stephen back at that time.

    Phil, What Buffett could or could not do has zero weight in my views on taxes, so in that sense I agree with you.

    Rick, Good question. Intellectual capital is a tricky subject. If we can measure investment in intellectual capital accurately (say cost of medical school) then that investment should be tax free. I.e. no taxes should apply to education if we have a VAT tax. With a VAT tax both you and the hedge fund guys pay taxes as you spend–so it’s equal there.

    If the consumption tax is done via the payroll tax, it’s a bit harder. In that case human capital is overtaxed unless the government subsidizes medical education, as they do in Europe.

    Another issue with payroll taxes is figuring out how much of the earnings of hedge fund managers is wage income deserving of taxation, and investment income not deserving of taxation. I’d err on the side of taxing much of the income they get from managing the funds–i.e. I’d tend to assume it’s wage income.

  20. Gravatar of Jon Martin Jon Martin
    10. September 2011 at 06:23

    Buffett: “I pay 27% of my income in tax. It’s too low”.
    Sumner: “You don’t pay 27% of your income in tax”.
    Buffett: “I do. I know, I’m good at math”.
    Sumner: “But your calculation is based on how tax rates are actually calculated, rather than how I think they should be calculated”.
    Buffett: “But you realise that everyone else in the world is quite comfortable talking about the ethics of taxation based on it as a percentage of income”.
    Sumner: “Of course, I’m not an idiot. But I thought I’d shoot you down anyway.”

  21. Gravatar of Christopher Walker Christopher Walker
    10. September 2011 at 06:32

    “Income” might be meaningless in economics, but it isn’t meaningless in tax theory. Just because Buffett doesn’t subscribe to your idea that consumption is the only thing that matters hardly means he “doesn’t understand tax theory.” By your definition, Buffet could simply decrease his tax liability by spending more, which is what we should be encouraging wealthy people to do in the first place.

    I’ve never understood the appeal of taxing consumption in a consumer-driven economy. When wealth inequality is at an all time high, it seems the most efficient way to reallocate resources is to tax money that is just sitting there as opposed to discouraging people to participate in the economy vis a vis a consumption tax.

  22. Gravatar of Christopher Walker Christopher Walker
    10. September 2011 at 06:33

    Eh, Jon Martin said it better than I could.

  23. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 06:33

    Jon, Not everyone in the world, just those people who don’t understand the first principles of tax theory (which is admittedly a big chunk of the world.)

  24. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 06:38

    Christopher, Saying this is “my theory” is like saying S&D is my theory. It’s the standard model. If people don’t like it they should show why it’s wrong. Until then I’ll assume it’s right.

    If Buffett gave advice on string theory people would laugh at him. Is that cruel? So why shouldn’t we hold him to account for pontificating on a subject he knows NOTHING about other than his gut instincts. Liberals criticize the right for its know nothing attitude on global warming, how they reject the expert model. OK, why aren’t liberals criticizing Buffett?

  25. Gravatar of Justin Justin
    10. September 2011 at 06:53

    Christopher- How do you tax income that isn’t spent? The whole point of taxation is to transfer one person’s resources to somewhere else. If I don’t consume fewer resources after being taxed, how can someone else consume more? The only way is if someone else’s consumption is being crowded out, which suggests that I’m not really the one being taxed at all.

  26. Gravatar of Lance Lance
    10. September 2011 at 07:14

    Scot, I agree with the thrust of your post, but I think you get the mechanics of double taxation wrong.

    Double taxation does not exist because labor income is taxed and then capital gains derived from your labor income is taxed. This is so because your basis is established by your labor income, which is not taxable. You are only taxed on recognized capital appreciation.

    However, double taxation does exist with respect to the taxation of corporate income and capital distributions from that corporation. Corporate income taxation reduces the equity returns of shareholders. Tax number one. Tax number two occurs when that corporation makes distributions and shareholders are taxed on that income or when the stock value appreciates (assuming stock value is the NPV of expected cash flows) less than it otherwise would have in the absence of taxation and the subsequent lesser appreciation is then taxed.

  27. Gravatar of Jon Stokes Jon Stokes
    10. September 2011 at 07:24

    Scott, I guess I just disagree with your moral premises. Specifically, you seem to feel strongly that saving is good and should be encouraged, and consumption–or, rather, excessive/conspicuous consumption–is bad and should be penalized. (And please don’t deny the moralizing about consumption… it’s in the tone of the post and it’s clear that you’re at least deliberately striking this rhetorical chord with the audience, regardless of what you truly think in your heart of hearts.)

    This moral stance is fine I supposed, but it’s not the only one. Buffett is equally moralistic in his tax arguments, but he starts from the premise that extreme wealth disparity is “unfair”, and that’s the unfairness that a higher income tax will address. It’s deliberately confiscatory, and it presumes that, regardless of how unfair it is to confiscate wealth and punish savers and all that, it’s even more unfair if–for whatever combination of merit and luck–a very small group of people ends up with most of society’s wealth than a very large group of people.

    Here we also get to the first question I raised, which is about the utility of wealth. You might argue that it shouldn’t matter if only a handful of Buffetts are sitting on most of the country’s wealth, because if they’re not spending it on consumption or philanthropy, then they derive no utility from it. But this is very false, although I can see how someone with no wealth may think that way (I don’t say this as a slight… you may be wealthy but I presume from the fact that you’re a Prof that you aren’t… I say this as a dangling humanities PhD from Chicago :)

    In this respect, I can object on the basis of two biographies: Buffetts, and my own. I sold Ars Technica and suddenly became wealthy, and I won’t go into detail on the very large amount of utility that I derive merely from the fact that people know that I sold my site and roughly for how much (these details were widely reported.) I get opportunities for increasing my wealth and consumption, for bettering my children and family, and for accessing people and things and experiences that people who are in a different social strata will never understand–all without actually spending a dime.

    Then there’s Buffett, who according to Schroder’s biography derives immense utility from his status as one of the world’s richest men, regardless of what he doesn’t spend. There’s the “elephant bumping”–rubbing elbows with the most rich and famous at parties and events. And then the personal utility that he derives from satisfying the “collector” side of his personality–the boy who was obsessed with model railroads now owns a giant railroad.

    At any rate, my only point is that the wealthy derive utility from their wealth in every aspect of their life (health, children, social connections, opportunities, etc.) that is far, far in excess of the utility that they derive from merely spending money. No, you cannot measure this utility the way you can measure spending, but Buffett’s argument is that even so it’s unfair that this utility–these benefits–are isolated to a very few.

    Ultimately, Buffett is a helluva lot more sophisticated than you want to give him credit for–I don’t think he’s at all ignorant of the points you’ve raised, regardless of the fact that he chose not to address them in the limited space of an NYT editorial. He just starts from different moral premises and arrives at a different place, without stopping in your neck of the woods. And personally, I like his moral starting place better than I like yours.

  28. Gravatar of Brian J Brian J
    10. September 2011 at 07:43

    Here’s what I don’t get about what you are saying. Buffet claims he’s paying a certain amount in taxes, which is too low and in fact lower than others around him, despite making far more money. He claims this is lower than those around him, which you attribute to the fact that his money comes from investment. You then claim he ignores double taxation, as does Greg Mankiw by extension, and Mankiw says that the corporate tax means he actually pays more than he lets on. The end result is that he’s paying more than he realizes or lets on.

    No doubt, this is definitely possible. But let’s assume for a moment that Buffet is more right than wrong and that a lot of people like him are paying less despite their potential ability to pay more. I do wonder (a) how much of this is because Berkshire Hathaway doesn’t pay dividends, as some have pointed out, (b) how much of this is because he takes advantage of loopholes and deductions that reduce his burden, and (c) to the extent that (a) and (b) are true, how true they are for other people like him. If he is more right than wrong, and not just for himself for people like him, I wonder he proposes to change this. Efficiency arguments aside, just how does he propose the wealthy pay more? (Not that such arguments are not important; they are, but then I feel as if there just aren’t many other sources of money if we leave out capital income–aside from pollution taxes and the like, but that’s another issue.) Indeed, I think Martin Feldstein’s argument that I saw him make on television–which is that, once you get passed all of the rhetoric and dig into his proposed solution of leaving most rates where they are but raising them for people making over $1 million a year, there’s just not that much money–is key. We could argue how this should happen and when it should happen, but it’s true that people besides those at the very top will need to pay more if we are going to have the same level of government spending that we seem to want.

    Also, care to explain this? “In the US the tax on investment income applies to nominal earnings; the tax rate on real earnings is far higher–over 100% for many Treasury securities.” I’m not saying you are wrong; I just don’t know enough about this to know you are right.

    As far as taxing yachts and so forth, a few things. First, please don’t like to Free Republic. It’s a cesspool worse than most places on the Internet, and for such a seemingly smart, well-intentioned guy like yourself to give them credit is depressing. Second, a (higher) tax on consumption might be bad for those industries, but isn’t a general one better than one that specifically targets certain industries, which is what the taxes in question from the link you gave seemed to do? Also, I can understand the hypothetical frustration you describe up to a point–but then, isn’t the solution to make sure the overall burden isn’t too high and the system fair, possibly by lowering other types of taxes?

    Which brings me to your support for a progressive consumption tax. There’s probably a lot that I don’t understand about it, and I might support it for different reasons than you. I’m not sure how to finance a certain level of government spending without taxing the rich far too much (more on that in a second). I hope I am not promising a free lunch here, but with a progressive consumption tax, it seems like it’s possible to get those at the very bottom to save more, to simply have more of a buffer but also to invest and take advantage of the one thing they will never get back, which is time, while shifting the overall burden of financing the government upwards but in a better way. We’d get a more progressive system, but one that has better incentives for everyone especially for those at the bottom, while also getting better economic growth, faster productivity (although I am not sure about this; I seem to remember reading it but can’t be sure), and higher incomes. We could also finance whatever government we want in a more efficient way. Unless you are a Grover Norquist type that hates government no matter what, what’s not to like?

    In particular, I feel like it’s a way to subsidize those at the bottom without being too explicit about it. I think you and I both agree it’s good economically, but I think it’s also an easier sell politically. In the same way that people, at least in my experience, are open to the Earned Income Tax Credit because people are actually working, I suspect a lot people would be more open to financing the government if they felt those at the bottom were acting in a responsible way, by saving and hopefully investing for the long term. And that’s before they might consider just how capital formation was emphasized, which would again make everyone better off!

    At the risk of letting my relative ignorance cloud my judgement and make me think this is a free lunch-style plan, I think a lot of people are being very narrow minded about this, if they are even considering it all. I’d LOVE LOVE LOVE for the House Progressive Caucus to formulate a tax plan based on these principles.

    There are a lot of questions I have about this, but this point is already long enough, so I will simply ask you if you know of a good, relatively non-technical source of more information.

  29. Gravatar of Derek Scruggs Derek Scruggs
    10. September 2011 at 07:55

    Buffet’s argument is a political one about fairness and income inequality, not an economics one about the nature of taxation. That’s why it was published in the NY Times instead of an economics journal.

    You say he doesn’t know what he’s talking about, but it looks to me like you’re arguing about deciduous trees vs. evergreens while he’s in a different forest altogether.

    Jon Stokes makes a couple of great points. I’m not wealthy like him or Buffet, but I have no debt and enough cash and passive income that I don’t really have to work for several years if need be. My income (which derives from an installment sale of a business) is taxed at less than 20% (including state taxes).

    I’m glad I pay lower taxes than my 9-5 working stiff neighbor, but I don’t really think it’s fair.

  30. Gravatar of Jason Jason
    10. September 2011 at 08:08

    I would like to second Jon Stokes. The richest people in the world benefit from merely the claim to billions of dollars. Large CEO pay tends to act as a signalling mechanism more than as income or consumption. Like peacock feathers, they attract mating opportunities and business opportunities alike. Buffett as once the certified richest man in the world doesn’t need conspicuous consumption to show he is wealthy.

    Essentially, these CEOs, billionaires and millionaires are taking from the stock of public attention, driving up prices for luxury goods, and sucking up investment capital for their own investments instead of being available for thousands of people. Ten thousand dollars in investments for one million people has far greater utility than ten billion dollars in investments for one person — just from the wisdom of crowds the investments are likely to do better and that represents lost utility. All of these should be taxed.

    The biggest problem I see is these CEOs and billionaires that get public voice on account of their income (not their consumption except inasmuch as it demonstrates their income) and that they tend to be so wrong about stuff they are opining on (or, charitably, just as right as the typical man on the street).

    I believe in the consumption tax at most levels of income/consumption. But there should be phased in a tax on income including investment income above a certain level to offset the lost utility from concentrating wealth. A certain amount of my six figure salary goes toward signalling (although most of it goes towards financing prior consumption as a poor student), so part of it should be taxed, too.

    In history, and across nations, high gini coefficient countries with either income as the measure of inequality tend to be poorer, so that should be taxed.

  31. Gravatar of David N David N
    10. September 2011 at 08:20

    I think this is not fair to Buffett. It’s not like he’s the only person talking about tax as a fraction of income. That’s how the tax rates are defined in the first place.

    Even if he was to concede your point and base his argument on consumption, it doesn’t change anything. The same progressive arguments can be made, on the basis of non-discretionary consumption as a fraction of total consumption, total income, or wealth. That fraction will be much higher for Buffett’s secretary than it is for him.

  32. Gravatar of Mark Mark
    10. September 2011 at 08:22

    The problem is conflation of the function (net in-place liquidation value of assets) with the derivative (income, capital gains, value added, sales, etc.).

    The result of this conflation is a brain-dead discourse in political economy.

    OF COURSE people who have vast property rights should pay more for the existence of the entity that upholds those property rights — just as they should pay more for property insurance.

    OF COURSE people who make X dollars a year should have zero tax burden as a result of those CHANGES in their net in-place liquidation value of assets.

  33. Gravatar of Sean DeCoursey Sean DeCoursey
    10. September 2011 at 08:48

    Scott,

    I misunderstood your argument. You’re saying that because the $$ originally used to buy the bonds/investments was taxed when the purchaser earned it, taxing the return on his/her savings is double taxation.

    Your blueberry/watermelon VAT tax argument is interesting, and theoretically sound, but suffers from several flaws, mostly because you’ve only viewed it as a theoretical model. Some problems with even a progressive VAT you either don’t mention or haven’t realized:

    1. VATs encourage tax avoidance like nobody’s business.

    2. VATs artificially inflate prices for goods, which markets seek to correct. In this case, the black market, which gives organized crime a huge shot in the arm. It can also turn otherwise honest retailers into occasional “gray market” merchants. See the current resurgence of the mob in America, driven in no small part by arbitrage on tax-free/black market cigarette sales.

    3. Exceptions to the VATs will be carved out, which will make it both less effective and less progressive.

    4. The system will be heavily gamed. I was living in northern Italy a few years ago at a CIMBA summer program when I was talking with one of the local businessmen and learned that most of the houses in town were only painted with primer because that way they were “unfinished” and the owners didn’t have to pay the VAT on them. No matter how many loopholes you close, someone will always figure out a way to change the game-state to create new ones. Much like how if you make anything idiot-proof, a better idiot will be invented.

    Also, the two overriding imperatives behind your theoretical model seem to be a desire for fairness (ultimately pointless, the tax code exists to get the government $$ to run itself and society, not to be fair) and an interest in not penalizing certain behaviors you argue are virtuous like saving, which is questionable as too high of a savings rate can cause economic growth and demand issues – see China/Japan. (I’m not saying China/Japan problems are a result of high savings rates, or that they haven’t reaped benefits from the same, I’m just saying that in one case it’s been a contributing factor to existing problems, and in the other it’s a long term worry)

    I get why you used theoretical non-existent investment instruments for your example, because you wanted to make a clear and concise, easily understandable argument, but when arguing for a real world policy those luck factors you mention w/regards to birth location also play a role. No matter how “smart” I am, I can’t invest like Warren Buffet because I don’t have his resources or reputation or contacts. Companies would not issue press releases if I bought their stock. All investments and all opportunities are not created equal. We shouldn’t treat them like they are, or like they occurred in an academic vacuum of perfect information and rational markets.

    If you have to insist on the tax code treating everyone fairly, you should remember that it’s entirely possible to treat everyone fairly without treating them the same. Indeed, treating everyone the same is in many ways more unfair.

  34. Gravatar of MPS MPS
    10. September 2011 at 08:50

    Actually his tax rate is well under 1%. You see because he gets to enjoy all the wonderful things of living in the USA, which are funded to the tune of well over 100 times his tax bill.

    I’m being silly of course and so are you. Why talk about tax rates at all? The point is to make decisions about how to fund public services. Your definition of tax rate, like mine, are not very illuminating in that context. (Your example proves the point: if WB pays over 90% tax rate, well then evidently tax rates well in excess of 90% would be perfectly acceptable by people like him, so what’s your point?) The normal definition is more illuminating, in terms of gauging the consequences of changing tax rates.

  35. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 09:17

    Everyone. Most people know that their common sense doesn’t allow them to understand string theory or quantum mechanics. But they think their common sense does allow them to understand tax theory. It doesn’t, you need to study really difficult theory, as the system doesn’t work at like like it appears to work. “Income” vanishes into the thin air the closer one looks. I’m not saying the wealthy shouldn’t pay lots of taxes–they should, at a higher rather than the not so wealthy, but income is not the right concept to tax. Just because Buffett has folksy common sense and is a great guy doesn’t give him the ability to discuss tax policy or string theory.

    Justin, Exactly.

    Lance, You are wrong about double taxation, read the post I link to at the top of this post.

    Jon, You said;

    “Scott, I guess I just disagree with your moral premises. Specifically, you seem to feel strongly that saving is good and should be encouraged, and consumption–or, rather, excessive/conspicuous consumption–is bad and should be penalized.”

    You can’t say you disagree with my moral premises until you understand them. I don’t think consumption is bad, I think it’s the whole point of working and saving. I just don’t think people who choose to consume in period two should be taxed at a higher rate than those who choose to consume their income in period one–read the first post I link to above.

    As far as the rest of your comments they are entirely based on a misconception about what I am arguing. I do think that richer people who have higher levels of lifetime consumption should pay more taxes than those with lower levels of lifetime consumption (in present value terms.) My complaint has nothing to do with egalitarianism.

    And you can’t claim that Buffett does understand what he is talking about when he makes one mistake after another. Of course he wants to pay more taxes, he knows it won’t affect his living standards at all.

    It doesn’t matter when Buffett gets utility from being the richest guy. Some people get utility from being clever or pretty–do we tax those things?

    Brian, If you support a progressive consumption tax then we agree. If only Buffett would do the same.

    Derek, You say you agree with Jon, but he completely mischaracterized my argument. I am not anti-consumption at all.

    My argument is also about fairness and inequality. That’s why I favor a progressive consumption tax. It has nothing to do with fairness vs. “economics” An income tax, even a flat rate income tax, is profoundly unfair because it taxes people at different rates depending on when they spend their money.

    You said;

    “My income (which derives from an installment sale of a business) is taxed at less than 20% (including state taxes).”

    But income is a meaningless concept, and shouldn’t be the basis for taxation at all. I have no idea whether you should be paying more taxes or less, but you shouldn’t be taxed on income. I’m criticizing a guy who wants to take our bad tax system and make it even worse.

    Jason, You said;

    “I would like to second Jon Stokes. The richest people in the world benefit from merely the claim to billions of dollars. Large CEO pay tends to act as a signalling mechanism more than as income or consumption. Like peacock feathers, they attract mating opportunities and business opportunities alike. Buffett as once the certified richest man in the world doesn’t need conspicuous consumption to show he is wealthy.”

    I completely agree, but that has no bearing on my argument. You people seem to think I oppose high taxes on poor Warren Buffett because I shed tears for how it would reduce his living standard. That’s not my argument at all. Justin seems to be the only person who understands the argument. The taxes “paid” by Buffett aren’t really being paid by him at all. They aren’t reducing his consumption, nor are they reducing his prestige.

    If it was just a question of whether I thought Buffett was a lucky guy, and deserved to pay more money–I’d say tax him 10 times more than today. But that’s not my argument at all.

    You said;

    “In history, and across nations, high gini coefficient countries with either income as the measure of inequality tend to be poorer, so that should be taxed.”

    You’ve got it backwards, it’s the high tax countries that are poorer, ceteris paribus. Even the Nordic countries rely mostly on consumption taxes, and tax capital fairly lightly.

    David, I’d have no complaints if he advocated more taxes on the rich, or a progressive consumption tax. But he is specifically advocated more taxes on capital–a really bad idea. There should be no taxes on capital income.

    You said;

    “I think this is not fair to Buffett. It’s not like he’s the only person talking about tax as a fraction of income.”

    Look, at a minimum he needs to talk in real terms, not nominal terms. What if Buffett said the average person in Zimbabwe was richer than him because in nominal terms they make more? Would you give him a pass and say most people talk about income in nominal terms?

    Mark, Can you restate that in English?

  36. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 09:38

    Sean, You are still misunderstanding my argument. I want to tax the wealthier people more highly, but I base it on resources, not income.

    I am well aware that VAT has lots of evasion, but so does other taxes. I favor a progressive payroll tax. If the government needs to raise lots of revenue, then a progressive payroll tax plus a VAT. Land taxes and carbon taxes are also good ideas.

  37. Gravatar of Brian J Brian J
    10. September 2011 at 09:53

    Scott, here’s a more basic question, one that you might have already hinted at but that I might have missed since I’m not an expert: just how much more do these people pay, if they do in fact pay more?

    Perhaps I’m looking at the wrong information or not understanding what I am looking at, but everything I’ve seen says that the burden ends up being that the rich do pay more, but not that much more given their income and wealth. In other words, the differences in effective burdens just aren’t that drastic–not nearly as drastic as you’d think given all of the rhetoric. It doesn’t seem like he’s arguing over what should be taxed so much as how much in the end they are taxed. He wants the burdens to be changed.

    Or am I just not looking at the right information and/or mixing up the notions of burdens? If so, what are the true effective burdens?

  38. Gravatar of Will Will
    10. September 2011 at 10:20

    Actually, I learned from Steve Landsberg that Warren Buffett’s tax rate is 0 percent. “For the government to consume more goods and services, somebody else must consume fewer.” Buffett’s consumption clearly can’t be lowered.

    Maybe the government is taxing Buffett’s saved money, though? No. “That, right there, is the heart of Ms. Steven’s confusion. She thinks that green pieces of paper, or a series of zeroes and ones in a bank computer, can somehow help supply the government’s demand for actual goods and services. It can’t.”

    I get that the point is about tax incidence, which is an interesting issue, but these hyperbolic rhetorical postures — “Mr. Kendrick can’t be taxed!” “Warren Buffett paying 90 percent!” — obscure more than they illuminate.

  39. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 10:33

    MPS, You said;

    “Actually his tax rate is well under 1%. You see because he gets to enjoy all the wonderful things of living in the USA, which are funded to the tune of well over 100 times his tax bill.”

    He gets $700,000,000 million in “enjoyment”? Wow, he must be a lot happier than me!

    And the reason we talk about tax rates is because they affect behavior at the margin. And also because we are interested in equity.

    Brian, You said;

    “Perhaps I’m looking at the wrong information or not understanding what I am looking at, but everything I’ve seen says that the burden ends up being that the rich do pay more, but not that much more given their income and wealth.”

    People will never understand this stuff unless they stop thinking in terms of income–it’s a meaningless concept. Think in terms of consumption. The first link in this post explains why.

    His burden is the extent to which taxes hurt him. I doubt they hurt him at all. When he “pays taxes” it just means he gives less to the Gates Foundation. Which means his taxes are being paid by starving kids in Africa. I’m sure people will be shocked by this assertion, but unless you tax consumption, you really aren’t taxing someone at all.

    Admittedly most rich people are impacted by taxes, in most cases it does reduce their consumption. And that’s as it should be.

    Will, We are both right. I am talking about his legal tax incidence–which is more than 90% of taxes plus consumption. See my reply to Brian, the economic incidence of the tax falls on others.

  40. Gravatar of Mark Mark
    10. September 2011 at 11:15

    I have three basic questions for all would be political economists:

    1) If physicists conflated velocity with position the way you conflate income with wealth, where do you think technology would be today? Why do you think economic technology would be any better?

    2) If the primary function of government is to uphold property rights, then why is government funded by taxing economic activity rather than taxing property rights?

    3) Why don’t you ever answer the first 2 questions?

  41. Gravatar of Jon Jon
    10. September 2011 at 11:33

    Scott writes:
    “beowolf, I wouldn’t even tax the investment income at the point it reached the individual.”

    To reinforce this point, taxing distributions to individuals encourages retained earnings. Retained earnings mean firms get bigger and bigger. This raises some efficiency concerns. Maybe its good for firms to get bigger–in which case distributed earnings would be reinvested in those firms, but maybe its better for more investment in new or small firms. Taxing distributions is a distortion.

    Beyond the efficiency concern, I’m always surprised to hear voices on the left encourage high tax rates on distributions. Aren’t they a priori against “big corporations”? Their actions rather suggest otherwise.

  42. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    10. September 2011 at 11:51

    Have I wandered into a Thorstein Veblen convention by mistake?

    First, Buffet is the one making a ‘fairness’ argument, not Scott. If Buffet wants to change the average tax rate he pays he has the power to do just that by reorganizing his affairs so that he takes his income in the form a huge salary from Berkshire (almost all of which would be taxed at 35%) rather than as he does now, in the form of capital gains taxed at 15% (the only way he could be paying an average rate of 17%).

    I doubt I’m the only person who suspects that Warren organized his income the way it is now to avoid just those high tax rates he’s claiming investors like him ignore.

    Further, he complains that he shouldn’t be getting $36K in SS benefits because he’s so rich. Guess what, the govt. taxes half of that amount away from him right now, as it does to all high income people. So, even with regard to payroll taxes–his real gripe about his secretary’s tax rate–he’s paying (net of benefits) a much higher rate.

    He might also think about getting out of the insurance business if he’s so offended by people avoiding taxes, as that’s one of the few places left after the 1986 tax reform where there real advantages.

  43. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 13:14

    Let me say it this way…

    Income is very easy to manipulate, you can spread it out a million ways till Tuesday, and literally wait out the tax code changes.

    Consumption you can’t get around, you can only choose to have less of it.

    Scott my point is that, corporations shouldn’t get to have expenses that improve the livelyhood of the executive WITHOUT HIM / HER paying for it as directly as possible.

    WE WANT executives looking at the difference between coach and first class, between 5start and 3 star as $ they could put in their pocket.

    So under a strong progressive tax regime, corporations only get to write off coach, and the executive gets to agitate for a larger salary to cover the difference, and then HE DECIDES with the money in his pocket if he wants to ante up (and be taxed as well).

    A real consumption tax focuses on relentlessly on closing loopholes, for the same reason you have a consumption tax:to incentivize people to consume less, and to progressive tax those living highest on the hog.

  44. Gravatar of Derek Scruggs Derek Scruggs
    10. September 2011 at 13:19

    Scott, you’re making an argument about tax theory, not policy. You can blather all you want about consumption vs income, but it has no bearing on the way taxes have worked in the US for over 100 years.

    Buffet is making an argument that is much more relevant to the actual policy environment we all live in, not some idealized utopia.

  45. Gravatar of FQN FQN
    10. September 2011 at 15:07

    God bless Scott. I love it when he posts something completely reasonable that’s bound to drive a bunch of economic ignoramuses insane.

  46. Gravatar of FQN FQN
    10. September 2011 at 15:10

    Derek, Buffet was making an argument about tax theory too: he was claiming that both unearned and earned income should be taxed at the same rate. That’s not how taxes have worked in he US for (too lazy to check) years.

    Like it or not, Scott’s right, and furthermore, decision makers across the globe have been moving tax systems in the direcion of reducing corporate and unearned income taxes relative to earned income and consumption taxes for a number of decades…

  47. Gravatar of Hyena Hyena
    10. September 2011 at 15:58

    We could just as well argue that Buffett faces a real negative tax rate since he has a surplus after maximizing his utility. We could much more greatly tax him and still expect the same result; in fact, if the US really were a thug state, it would do exactly that and seize that surplus until Buffett’s work product would decline sufficiently that greater seizure produced less income for the state.

  48. Gravatar of MikeDC MikeDC
    10. September 2011 at 16:00

    Chaco and Scott,

    Buffet explicitly mentions that poor people are “sacrificing” by being the majority of war fighters thus the right should pay more.

    While you guys are busy saying that’s a reason Buffet shouldn’t donate, Buffet’s busy not donating but arguing you guys should be compelled to pay. Oh the irony!

    (David Henderson really took him to task for it a few days ago).

    Phil, No, you can’t donate to specific government entities, only to the treasury. I’d say his failure to donate is a revealed preference that undercuts his argument, not an argument against him.

  49. Gravatar of MikeDC MikeDC
    10. September 2011 at 16:05

    Damn I meant “Buffet explicitly mentions that poor people are “sacrificing” by being the majority of war fighters thus the wealthy should pay more.”

  50. Gravatar of Rick Rick
    10. September 2011 at 17:37

    I basically agree with Scott, but let me try a compatibilist approach based on the best of the commenters’ arguments.

    One of the common objections to consumption-only taxes is that non-consumed income still leads to increases in status and opportunities for the rich that are themselves inequality, even if they never lead to increased consumption. Increased access to investment capital was cited in the comments above, and it was suggested that this is disproportionate to merit, i.e. that rich people are getting to control more capital than is optimal from an efficiency standpoint, because investors are susceptible to the Gambler’s paradox and assume that someone who sold a company for lots of money is particularly skilled rather than lucky and investors want to invest in the person, above and beyond the merits of their business plan.

    Supposing this is true, a tax on income isn’t going to change the fact that rich people will have this benefit, namely increased access to capital. The richest guy in the world is still the richest guy in the world no matter how progressive the tax is (assuming it is broad-based), and people will want to give him their money to invest. However, increasing his income/capital gains tax will decrease *his* rate of return, which will make him less likely to take all that extra money he has access to and invest it. If he takes it anyway, and pays the tax, as Scott said the incidence of tax is not on him but on whosever consumption is decreased.

    But maybe we don’t care. Maybe the goal is not to stick it to him, but (1) to open up investment opportunities for people paying a lower income tax rate (and getting a higher rate of return), whom capital will find after the high-tax-paying people pass it up. Or maybe the goal is (2) to collect as much tax revenue as possible in the sneakiest possible way, since soaking the rich is more politically achievable than taxing a broad base, even if the true incidence of the tax is the same. (1) could be a good idea, if it helps leverage the wisdom of the crowd is really important or status signalling is playing way too big a role in determine capital access; or it could be a really bad idea if the people who know how to do the important things in the economy are the really rich guys. Maybe we want Carl Icahn to take over Yahoo. (2) could be a good idea if we are really struggling to pay federal bills, or a bad idea if it leads to a too-large public sector.

    But I think these are arguments that take place outside of the “What is the true incidence of the income and capital gains tax?” argument, which can be conceded to Scott while leaving important questions open.

  51. Gravatar of Steve Roth Steve Roth
    10. September 2011 at 18:26

    >Then read this link.

    Scott, this is a perennial red herring that really must have a stake driven into it.

    I think you’re probably not aware — because the propagators of this fishy item never mention it — that the tax was only on *domestically produced* products.

    The problem was not that it taxed luxury items, but that it was a self-inflicted reverse tarriff! Sales of imported luxury goods increased, as one would expect.

  52. Gravatar of bob bob
    10. September 2011 at 18:51

    Make money in this theoretical US that has no income tax, do most of my spending in a country that has a very low consumption tax. Sounds like a nice dodging plan.

  53. Gravatar of Rick Rick
    10. September 2011 at 19:10

    I basically agree with Scott, but let me try a compatibilist approach based on the best of the commenters’ arguments.

    One of the common objections to consumption-only taxes is that non-consumed income still leads to increases in status and opportunities for the rich that are themselves inequality, even if they never lead to increased consumption. Increased access to investment capital was cited in the comments above, and it was suggested that this is disproportionate to merit, i.e. that rich people are getting to control more capital than is optimal from an efficiency standpoint, because investors are susceptible to the Gambler’s paradox and assume that someone who sold a company for lots of money is particularly skilled rather than lucky and investors want to invest in the person, above and beyond the merits of their business plan.

    Supposing this is true, a tax on income isn’t going to change the fact that rich people will have this benefit, namely increased access to capital. The richest guy in the world is still the richest guy in the world no matter how progressive the tax is (assuming it is broad-based), and people will want to give him their money to invest. However, increasing his income/capital gains tax will decrease *his* rate of return, which will make him less likely to take all that extra money he has access to and invest it. If he takes it anyway, and pays the tax, as Scott said the incidence of tax is not on him but on whosever consumption is decreased.

    But maybe we don’t care. Maybe the goal is not to stick it to him, but (1) to open up investment opportunities for people paying a lower income tax rate (and getting a higher rate of return), whom capital will find after the high-tax-paying people pass it up. Or maybe the goal is (2) to collect as much tax revenue as possible in the sneakiest possible way, since soaking the rich is more politically achievable than taxing a broad base, even if the true incidence of the tax is the same. (1) could be a good idea, if it helps leverage the wisdom of the crowd is really important or status signalling is playing way too big a role in determine capital access; or it could be a really bad idea if the people who know how to do the important things in the economy are the really rich guys. Maybe we want Carl Icahn to take over Yahoo. (2) could be a good idea if we are really struggling to pay federal bills, or a bad idea if it leads to a too-large public sector.

    But I think these are arguments that take place outside of the “What is the true incidence of the income and capital gains tax?” argument, which can be conceded to Scott while leaving important questions open.

  54. Gravatar of Floccina Floccina
    10. September 2011 at 20:31

    Some people seem to missing the fact that person who writes the check does not necessarily pay the tax. A good example from my life is that I write a check for the property tax on the apartment that I own but it is in a competitive market so absent the tax I would have to change less for rent, so the tenant pays that tax through their rent.

  55. Gravatar of MikeDC MikeDC
    11. September 2011 at 05:42

    The more I think over the consumption tax, the more confusing it gets. Suppose I’m taxed 20% on a $1000 capital gain. So if I cash it out and give it to the United Way, or invest it in my sister’s business idea, I can only donate/invest $800. The other $200 goes to the gvt.

    With a 20% VAT, I’m not taxed on the capital gain and I donate/invest $1000. However, the United Way or my sister has to pay the 20% VAT (or 20% payroll tax if you prefer) when they use the money, so at the end of the day they still only get a purchase of $800 worth of “real” goods and services.

  56. Gravatar of Cahal Cahal
    11. September 2011 at 06:48

    Am I not right in saying that where complicated consumption taxes have been implemented, they have been incredibly unsuccessful and destroyed industry? Whereas countries did pretty well with 90% marginal rates on both income and CGT for half a century?

  57. Gravatar of Derek Scruggs Derek Scruggs
    11. September 2011 at 08:07

    FQN, which seems more politically feasible:

    1. Raise taxes on investment income (or perhaps lower on earned income to bring parity)

    2. Throw out income taxes — something for which we explicitly amended the Constitution — altogether and move to a consumption tax

    I don’t have an issue with arguing which is better, but it’s silly to go after Warren Buffet. He lives in and works in the world of reality, which perhaps explains why he’s wealthier than all the world’s economists who ever lived combined.

  58. Gravatar of Pat Larkin Pat Larkin
    11. September 2011 at 12:32

    Scott,

    I think that I do understand the first principles of tax theory. Your posts have been helpful in getting me back up to speed on it. But I think that there is another important aspect of this if we are talking about fairness and not just efficiency. In the aggregate, saver/investors get a rate of return equal to the economy’s rate of return. In our actual economy, many saver/investor’s get a negative rate of return, and most others get substantially less than the rate of return on the overall economy. It is well known that the average mutual fund investor earns far lower compounded returns than the funds that they invest in. All of this is possible because most savings vehicles are securitized assets and securities markets can be wildly volatile. This means that even if capital is not taxed, the present value of the lifetime consumption of most saver/investors is less than it is for non-saver/investors. On the other hand, a few saver/investors like Buffett and those at the very top of the hedge fund and private equity world earn enormous rates of return and make a tremendous amount of money. They have made so much money in some years that they accounts for a good portion of overall income inequality. In the interest of equity, one could make an argument that these big winners should pay taxes on their capital income because it did not come from deferring consumption but from winning at the capital allocation game. I think this is really what Buffett is advocating. Also, I think that he is saying that the fees earned by investment managers are labor income and should be taxed as such. In that sense he is really advocating a much bigger tax hike for his “friends” in hedge funds and private equity than for himself, as he only earns $100,000 per year for managing Berkshire’s investments and acting as CEO.

    Also, I think that it is pretty clear that Buffett understands the effect of inflation on real tax rates. His 1977 Fortune article, “How Inflation Swindles the Equity Investor” contains this quote:

    “The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5% passbook account whether she pays 100% income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5% inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120% income tax, but doesn’t seem to notice that 6% inflation is the economic equivalent.”

    I don’t agree with everything that Buffett says about taxes and politics, and I agree with a lot of what you say about taxes and other economic issues, but in my opinion you went a bit far in labeling Buffett a total innocent on taxation.

  59. Gravatar of Mark Mark
    11. September 2011 at 13:28

    Scott,

    Confusing people about the distinction between “wealth” and “income” and then progressively taxing income while claiming to be taxing the “wealthy” is probably the worst single political economic crime possible to commit in public discourse.

    “Wealth” is not “income”. “Wealth” is property rights – net assets – the net in-place liquidation value of assets, etc.

    Since the primary function of government is the protection of non-subsistence property rights, it is sensible to charge a use fee for those rights. Note, I said “non-subsistence” property rights. The point here is that house and tools of the trade are protected from confiscation under bankruptcy law precisely because they are subsistence assets. Where government does not exist, subsistence properties are typically defended by the occupant, whose life is sustained by those assets. Government brings precisely the property rights we associate with civilization — assets beyond home and tools of the trade.

    Failing to charge a use fee or tax for property rights allows the truly wealthy, whose property rights would disappear in an instant in the absence of government protections, to continue to accumulate net assets without limit and without paying the costs of protection of those property rights—shifting them onto the heavily taxed producers.

  60. Gravatar of Rick Rick
    11. September 2011 at 16:17

    Floccina,

    You may rent in a competitive market, but to the extent that the property tax is land value and not improvement, it’s a market with fixed supply. Which means that absent the tax supply doesn’t change which means rents don’t change. So you as the land-owner are paying the incidence of the tax. If your jurisdiction assesses building values (as most do) then supply is elastic with respect to the tax rate and so renters share some of the incidence. This why the case for land value tax (as distinct from property tax generally) is so strong.

  61. Gravatar of Mark Mark
    11. September 2011 at 20:24

    The problem with “property” taxes is they are applied to the homestead value. This is inexcusable since a person has a homestead in the absence of government just as any animal possesses territory from which it derives calories to sustain it. So NATURALLY people resent “property taxes”. They aren’t legitimate without some sort of compensation.

    The only situation in which it is legitimate to tax homestead property value is when there is a citizen’s dividend whose net present value is equal to the median price of a home plus the median capitalization of a job. In this situation the economic rent stream received by the citizen is compensation for his investment of his homestead in the body politic.

    Self-assessment is inferior to in-place liquidation value assessment as determined by the highest bid placed in escrow for the property right. It is then up to the owner of the property right to either accept the bid and transfer title, or pay the interest on the escrowed bid. When the government places the high bid it receives the stream. Bank accounts are, of course, assets whose liquid value is by definition their balance. If there is no citizen’s dividend then savings accounts collect the interest up to the homestead limit — replacing FDIC.

  62. Gravatar of beowulf beowulf
    11. September 2011 at 20:24

    Mark and Rick,
    So a net asset tax with a tax credit given for land taxes paid to state/local govts, states and counties would quickly shift as much of tax burden as they could to land value or they’d be forcing their residents to pay unnecessary federal taxes.

    It should go without saying that any tax reform that isn’t revenue-neutral (for entire govt sector, if a mop up tax credit is offered for land taxes) is doomed. There are sometimes voting majorities in Congress for increasing taxes and sometimes majorities for reforming tax code but there are never both at the same time for the same bill.

  63. Gravatar of Morgan Warstler Morgan Warstler
    11. September 2011 at 21:08

    Mark, property taxes ARE consumption taxes.

    And the value of the property must be assessed yearly. In CA, you get people owning on the coast and paying taxes based on their 1973 purchase price. They are CONSUMING coastal views.

    But in TX, it is done right, just sales and property. So a poor guy in a neighborhood that gentrifies, suddenly can’t afford his tax bill. After all, he’s living in a cool neighborhood, even if he go there long before it was cool.

  64. Gravatar of Mark Mark
    11. September 2011 at 22:58

    Consumption presupposes possession i.e. property rights.

    When you possess something there is a cost to defending your right to possess that thing.

    The primary function of government is upholding property rights that wouldn’t exist in the absence of law enforcement.

    When you have taxes on economic activity (income, capital gains, value added, sales, etc.) rather than taxes on (use fees for) the use of non-subsistence property rights (which are the primary constructs created by governments), you socialize the costs of property rights protection. It becomes a government subsidy of wealth.

  65. Gravatar of Bernard Yomtov Bernard Yomtov
    12. September 2011 at 05:53

    Among other things, I’m curious why philanthropy isn’t considered consumption. If I buy you something it’s consumption. If I give you the money and you buy it it’s not?

  66. Gravatar of Scott Sumner Scott Sumner
    12. September 2011 at 10:08

    Mark, I don’t conflate income and wealth, and I don’t see the government’s role as primarily upholding property rights. And even if I did, that would have no bearing on what I thought the optimal tax system was.

    Patrick, Yes, and I’d add that it’s liberals who often oppose turning SS into a welfare program for the not well off. They worry it would be the beginning of the end for political support.

    Morgan, I agree that execs should have to pay for their perks.

    Derek, And liberals can blather all they want about global warming but it has no bearing on the way we’ve used gas taxes to finance highways for 100 years. I find it amusing to see liberals now taking the populist, anti-science viewpoint. And BTW, I am talking about policy, just like Buffett. I’m opposing his call for higher taxes on investment income.

    FQN, Given how the left likes to bash the right for being anti-science, I’m loving it too.

    Hyena, Throughout much of human history the leaders tried to move taxes to the top of the Laffer curve, that’s what held back progress.

    MikeDC, You said;

    “Buffet explicitly mentions that poor people are “sacrificing” by being the majority of war fighters thus the right should pay more.”

    Talk about a non sequitor! I didn’t know most military people were poor, and I didn’t know they were leftists. You sure could have fooled me. BTW, I do favor progressive taxes, so even if he were right your observation would have zero bearing on my post.

    Oops, you clarified it. Well I still wonder whether most military people are poor. Does anyone know?

    Rick, Sure, one could always make up any argument you wanted. But I’d still rather have Buffett invest the money (or donate it), rather than spend it on consumption.

    Steve, I think it did apply to foreign produced new boats. But in any case why didn’t the Dems call for the tax being extended to domestic and imported luxuries?

    Bob, The consumption tax I favor is a payroll tax. So that strategy wouldn’t work. In any case the rich can take their wealth out of the US right now, can’t they?

    Floccina, Good point.

    MikeDC, You are ignoring the double taxation of money with an income tax. That’s avoided with a VAT or payroll tax replacing an income tax.

    Cahal, Yeah, you are wrong. Consumption taxes are viewed as quite efficient.

    Derek, Even if we must have an income tax, why make it even worse? Better to allow unlimited 401ks, and then higher tax rates for the rich.

    And by your argument Donald Trump is much smarter than you. Is that your view?

    Pat, OK, Buffett does understand tax theory, he just acts like he doesn’t. I’m fine with that.

    I’m still not sure you understand my point. I’m fine with a progressive consumption tax, which would make the lucky SOBs pay up. But it should be based on consumption, not income.

    Mark, I addressed your property rights point elsewhere.

    I don’t have much interest in natural rights views.

    Bernard, You could do it either way. If Buffett gives a poor person $500, and he buys a stove, you could apply the consumption tax to Buffett, or to the poor person. The effect is identical. But don’t apply it to both, that’s double taxing the same consumption.

  67. Gravatar of Mark Mark
    12. September 2011 at 12:17

    Scott,

    I wasn’t saying that you specifically conflated it.

    And although it might sound like I’m making normative claims, I’m making descriptive claims about what happens structurally to the economy regarding asset centralization under certain tax regimes.

    Political rhetoric defining “the rich” or “the wealthy” as those with high levels of income or capital appreciation, focuses public sentiment against the most productive members of society and away from the centralization of net assets as the underlying problem.

    The incentive for productivity in the economy, left after the disincentives of capital welfare are subtracted, is the long-term economic growth rate minus the interest rate on the national debt. When the interest rate being paid on the national debt equals the growth rate of the economy, the fruits of all productivity are being confiscated to pay capital welfare and the incentives for productive investment and labor disappear. When the incentives for productivity become negative due to capital welfare in excess of the economic growth rate, wealth is structurally centralized at the expense of others in the economy. The absolute level of net assets owned by the general population actually decreases so as to increase the net assets of the wealthy. This not only removes all incentives for production and entrepreneurial investment from the economy, but consumer demand collapses as credit is liquidated to pay for necessities.

    Depression ensues.

  68. Gravatar of MikeDC MikeDC
    12. September 2011 at 15:43

    Scott,
    Military service members are certainly not objectively poor. A buck private enlisting out of high school makes on the order of $1450/month in basic pay, Which sounds pretty meager until you throw in 100% free food, housing, and medical care, plus significant drill pay, hazard pay and training opportunities and compensation they wouldn’t get as a comparable civilians. The military is actually having some difficulty “shedding” soldiers who don’t want to become civilians these days. Pretty much what’d you’d expect from a volunteer force.

    —-

    Regarding the income vs. payroll/VAT, that’s true for payroll OR VAT, but I thought in practice you were willing to submit to both a payroll tax and a VAT, so wouldn’t double taxation be in effect there as well?

    Income tax: I earn $50,000 of income in a year, and pay 20% up front in an income tax. I then invest the remaining $40,000 and reap a 5% capital gain of $2,000. I pay 20% capital gains tax, $400 to the government, and give the remaining $1,600 to the charity/investment.

    Payroll+VAT: I earn $50,000 of income and pay 20% up front as a payroll tax. My capital gain up front is $2000, but the charity/investor must pay the VAT+Payroll tax when they spend the money, so they’d still net only $1600 and the govt would still net $14,000.

    The result is the same regardless of whether it’s two taxes levied once or one tax levied twice.

  69. Gravatar of Mark Mark
    13. September 2011 at 12:15

    There is justification for charging insurance premiums for the protection of property rights that would not exist in the absence of governmental infrastructure. There is no such justification for taxing transactions, including consumption. All you are doing is introducing economic planning based on your own economic theory by favoring consumption tax. Net asset taxation of non-homestead assets replacing other taxes is moving the system away from this kind of planning and towards greater legitimacy.

  70. Gravatar of ssumner ssumner
    13. September 2011 at 18:02

    Mark, You said;

    “When the interest rate being paid on the national debt equals the growth rate of the economy, the fruits of all productivity are being confiscated to pay capital welfare and the incentives for productive investment and labor disappear.”

    I don’t follow–is that still true if the national debt is only $1?

    MikeDC, You are comparing apples and oranges. You need to compare an income tax with a VAT/Payroll tax combo where the two rates add up to 20%, such as a 15% payroll tax plus a 5% VAT.

  71. Gravatar of Dave Dave
    17. September 2011 at 12:13

    I didnt read all the comments, so forgive me if someone already said this. I think Buffet knows A LOT about the tax code- he also knows the average American doesnt. He’s probably saying these things to make himself look good/humble to the average American. That he’s just a regular guy, you know?

  72. Gravatar of ssumner ssumner
    18. September 2011 at 09:18

    Dave, Maybe, I just respond to what he says. Obama has a new tax bill proposal named after Buffett, so he has influence.

  73. Gravatar of Rowe Row « azmytheconomics Rowe Row « azmytheconomics
    30. December 2011 at 10:38

    [...] You can’t tax people who aren’t born yet for the same reason you can’t tax Warren Buffett. They don’t consume anything. I’ll leave it as an excercise to the reader to figure out [...]

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