A Counterpoint To Warren Buffett’s Tax Logic

At this point in time, the United States is about to hold a very critical debate that’s really important to the future the country. The debate is about whether or not to tax, consume and redistribute income that would otherwise likely be invested.

When Warren Buffett weighed in with his opinion, he told us that he supports higher taxes on our nation’s wealthy taxpayers. But the information that he uses to make his point is both flawed and superficial.

Warren Buffett is chairman and CEO of Berkshire Hathaway Inc., and he’s an iconic leader. It’s no question that the US needs insightful guidance from this investing genius. But the claim that higher income earners should pay more taxes, and this will not reduce investments, is counter to all economic logic.

A survey by the Federal Reserve shows that the top 5% of all households save and then invest about 40% of their total income. Households of a median income save hardly anything at all. In the Buffett household, they probably invest about 99% of their total income.

So, if America is to consume, tax and redistribute money that would otherwise have been invested, the investable pool of savings begins to disappear. With that said, the less attractive investment opportunities will logically go without funding.

Buffett also claims that investors are going to continue to invest in opportunities where returns are expected to go above the cutoff point. But at that margin, the investment is lost.

During his examples, Warren Buffett uses the 1950s and the 1960s as his timeframe of proof. At that point, marginal tax rates were a lot higher. So he claims that because the economy grew much quicker back then, it’s feasible that our economy will grow faster today with the same higher marginal tax rates.

But he fails to mention two important factors that took place during the 1950s. We had the advent of interstate highways, and the boom in creation and distribution of the television, which really pulled together the US economy. So you had large companies like Procter & Gamble and General Motors rushing to fund and exploit these previously unrealized economic opportunities. The result of that being that individual tax rates didn’t matter as much to less growth as they matter today. The growth rate acceleration was completely independent of the tax rate.

Plus, the United States had put its workforce into college a lot earlier than the rest of the world. That also created a lot more new investment opportunities. There were two decades of underinvestment in the private sector – this was during the Great Depression and World War II – which provided a lot further potential for an economic rebound. The cost of food fell by 20%, and the GDP dropped to less than 10%, which provided a lot more resources to fuel the boom in manufacturing.

Back then, a much smaller portion of GDP was also taxed at that time. And, local, state and federal government spending was roughly 28% of GDP, where it’s now closer to 40% at this point in time.

Using the 1950s and 1960s as evidence to increase government consumption by raising taxes on the wealthy, shows us that it played no meaningful affect on economic growth. As a matter of fact, it showed us that investments matter more than ever.

Buffett also tells us that the commercialization of the Internet during the early and mid-1990s created a large tailwind that ultimately benefited the rich – basically saying that investors didn’t do much to earn this success. There are many other proponents of higher taxes and spending who often use the same argument – saying that the 1990s showed us that placing higher taxes on investors isn’t going to hurt economic growth. They say commercialization of the Internet would have accelerated growth regardless of the tax rate.

If you compare the growth of the US with Europe during that early 1990s, you can remove the Internet effect. Both of the economies had the same technology, and the workforces were similarly educated to take advantage of the opportunities on the Internet. Since then, the United States economy grew by 63% up until the year 2010, but Germany and France combined grew less than half of that amount. Productivity growth in the United States between the years 1972 to 1995 increased from 1.2% per year to 2% between the years 1995 to 2004. On the flip side, Germany and France’s productivity growth dropped to less than 1.5% each year.

If there was no US innovation involved, the growth in Europe would have even been slower.

There’s truth to the matter that high labor redeployment costs limited Europe’s transition to move away from manufacturing. But it doesn’t fully explain why talented and young European workers held onto jobs in declining industries, while their counterparts in America happily walked away to join risky startups instead of sticking with their otherwise promising careers.

Well for starters, in the US there were higher payouts that drove employees to take greater risks. The most promising of US students flocked in droves to business schools, and were willing to work much longer hours than their counterparts who were being underutilized in Europe. The European work effort actually declined. The success of these early American startup companies created such large Internet businesses like Facebook and Google, among countless other companies that provided immense on-the-job training to the US workforce. This training provided much-needed increases in the chance to have entrepreneurial success.

And the entrepreneurial success we’ve seen put more equity in the hands of investors willing to take risks in order to improve innovation. It’s no surprise that the US has more equity per dollar of GDP then both Japan and Europe, as well as more innovation.

Even though the commercialization of the Internet actually created a tailwind, much of that tailwind was definitely earned.

During that 1990s, federal spending was also a lot lower than it actually is today. It was 18% of GDP at that time, versus the current 24%. As well local and state government spending was also much lower too. Because of this, President Bill Clinton was able to increase taxes across the board in order to pay down US debt. This was a good move and was able to strengthen the US economy. In today’s world, paying higher taxes is going to fund an increase in unproductive consumption, which will seriously slow down economic growth.

Far from showing that government spending and tax rates provided no effect on growth, on the contrary, the 1990 show us plain and simple evidence that payoffs for risk-taking, as well as accumulating equity, actually do matter.

This debate of whether we should tax, consume and redistribute income that would otherwise be invested is critical to the future of the United States. The US cannot afford to base this major decision on arguments that are superficial. The United States deserves much more from a leader such as Warren Buffett.

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