Throughout the years, Warren Buffett has gone very far in life with his folksy way of thinking and his ability to make difficult financial concepts very simple to understand. And as I’m sure you can imagine, people trying to push a higher tax agenda for the wealthy have also gotten a lot out of Warren Buffett’s way of thinking as well, since he is an advocate for this specific type of policy.
As you may or may not know, Warren Buffett is at it again this week, as he posted an op-ed piece in the New York Times – where he calls for a higher capital gains tax rate among other things.
For many years now, your capital gains have often been taxed at a rate lower than the tax on ordinary income. This was to help spur investments. The simple idea is that having taxpayers spend their money on wealth creating enterprises, will be much better off on the whole than if they were to waste their money on things like expensive vacations and consuming large amounts of luxury goods.
But the opinionated Warren Buffett had his own thoughts to share in regards to this logic, where he wrote:
“Suppose that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”
Would you potentially reply to this by saying something like “Well, it all depends on what my tax rate will be on again you’re saying were going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1%.” Only in Grover Norquist’s imagination does such a response exist.”
For the most part, Warren Buffett is making the argument that investors are going to continue investing no matter what amount of money the government takes in taxes after the investment is successful. So there’s no reason to worry about using the tax code as a way to encourage people to invest.
He instead suggests that we should start worrying that a lower capital gains rate is not fair to the people who earn the majority of their income through labor, which obviously pays a much higher tax rate under the current laws. He points out that this wrinkle in the tax code is the reason why former presidential hopeful Mitt Romney was able to pay such low tax rates in the years 2010 at 2011.
So who’s right on this issue? Are the economists on the left like Jared Bernstein, who is the former chief economic advisor to current Vice President Joe Biden, in which he argues that higher capital gains tax rates will not lead to any less investing. In a blog post that he made last summer, Bernstein showed us several different studies which prove that capital gains tax rate changes didn’t affect investing at all on any level.
In this post, he wrote:
“There are a few economic principles that we consistently get wrong in ways that do lasting damage to our economy and diminish our future. At the top of this list are arguments about large behavioral responses to changes in tax rates. I don’t think it’s zero, but I’ve simply never seen compelling evidence that tax increases significantly hurt growth, labor supply, jobs, wages, or that rate decreases provide much of a boost the other way.”
Many conservatives often respond that it’s very difficult to empirically prove these negative effects on higher capital gains taxes because the overall economy is such a complex, large beast with many different moving parts. As an example, the Internet boom sparked dramatic growth, which could very well have covered up any of the disincentives brought on by higher capital gains taxes when President Clinton raised them briefly during the 1990s – but it doesn’t show us whether or not and negative affect actually existed.
The second line in conservative arguments is that higher capital gains taxes also raised the cost of capital for all companies. When a firm gets equity capital, they do so by issuing shares on the stock market. If capital gains and dividends earned by those shares present a higher tax rate, then the overall share value will decrease – and this will result in the fact that lots of corporations won’t have enough ability to raise the money they need to hire more employees and continue to build factories.
Lastly, the Conservatives also believe that higher dividend and capital gains taxes are another way of “double taxation.” If you own stock in a firm that pays you out a dividend, the company paid taxes on that money already, so the individual investor shouldn’t have to pay taxes again. And then there’s the fact that when you sell a stock and realize a gain, there is the strong possibility that you bought that with money that was already taxed through labor income that you earned at your job or business.
If you are a wage earner of moderate wealth, you are already paying income tax at a higher rate, and this plan will have you also paying a higher rate of taxes on your investments. While you may not end up leaving your money in a bank account which Buffett jokingly mentions, it’s highly unlikely that you’re also going to start buying luxury goods. Why would you want to be taxed twice?
But this example basically applies to wage earners that are already moderately well-off, and this does not particularly represent all mainstream investors in the majority. Many of the investors are already wealthy like Mitt Romney, and they are basically just reinvesting the income that they made off of other investments which paid a much lower tax rate. Lots of them are also invested in the stock market through their 401(k) plans, which are basically funded by wages that are pre-taxed.
It’s safe to say that nobody really likes taxes. They are pretty much just a necessary evil that we need in order to fund our government. But since the middle class of this country is in a terminal state, it makes sense that the rich paying higher taxes on capital gains would be one of the best ways to raise revenue to get our budget deficit back under control.
Nobody is saying that Warren Buffett oversimplifies the case by increasing capital gains, and the basics of his argument do stand up to scrutiny. By raising capital gains taxes just a little bit, or changing the code so that they meet the rates of regular income, there will be plenty of investors still available to capitalize on the many incredible investment opportunities available today. They will not be disappearing anytime soon.