Former editor of the NYT Howell Raines (who, to the shock of absolutely no one, turns out to be an unabashed lefty ideologue) repeats the myth about Buffett’s secretary paying less taxes than he does:
As Warren Buffet points out, middle-income Americans ought to be protesting a system in which billionaires like him pay a third to a half of the 33% tax rate of Buffet’s secretary.
It is past time for this ridiculous claim to die. It’s had legs because tax law is somewhat arcane, but I’m here today in my capacity as a CPA* to cut those legs out from under it. I offer you the following simple explanation of why this claim is totally false.
Let’s say one day you decide to start a business, Bob’s Widgets. You’ve been in the widget industry for years, you think you can design a better widget that companies will find more efficient (less costly, more durable, etc). Risking all your own capital, you engineer, manufacture, and begin selling your widgets. Customers like your widgets, your venture is successful, and numerous people throughout the world enjoy the benefits of the productivity increase wrought by your improved widgets.
So, after a few rounds of of expansion and growth, your company is making $10M a year in profit. You pay the top marginal rate of 35% on nearly all of this, so we’ll be simplistic here and just call your tax rate 35%.
Since you’re not Elizabeth Warren and therefore not really, really excited about giving the gov’t $3.5M dollars (possibly because unlike her, you have some grasp of the proportion of the gov’t spending that goes to roads, police, and firemen), you call up your accountant and tell him “Hey, Howell Raines says that Warren Buffet guy pays less taxes than his secretary. My secretary sure as hell isn’t paying the gov’t 35% of what I pay her; in fact, I’m pretty sure she’s one of that majority of Americans who hardly pay any income taxes.” Noting that Warren Buffet seems to own C corporations instead of LLCs, you order your accountant to convert your LLC to a C Corp, stat!
And so it is done. And you’re sitting behind your mahogany desk, congratulating yourself on your cleverness and imagining various uses for the millions you have just saved (even better widgets!), when your accountant enters, clears his throat, and mumbles something about a corporate tax. You stare blankly. He goes on to mumble something else about a dividends tax. You begin to turn red. He continues mumbling about a capital gains tax, then runs from the room, just avoiding your chair which you have sprung out of and hurled at him.
Because, you see, you didn’t just save millions of dollars. In fact, you’re now paying taxes twice, first 35% at the corporate level, then again at the personal level on any dividends you receive — with both taxed at 35%, you are paying a total of 57.75% ( (1 – .35 ) * (1 – .35)) on the income that actually makes it into your bank account. That’s right, you are actually paying millions more in taxes than you did as an LLC (this is why, as Megan noted a while back, income has been moving from C Corps to LLCs for decades, which movement has driven increasing inequality in measurements of personal income in the U.S.).
And so you fire your accountant, who really should have told you this earlier, and vow that next time you’ll look for a licensed CPA instead of just hiring the first guy that shows up and asks for the job.
Still fuming, you decide to sell your company to Warren Buffett, and find out what exactly he’s been doing to avoid all these taxes you’ve been paying. (Howell Raines would never mislead you, he was the editor of the NYT!) Buffett agrees to buy your company at a P/E ratio of 10:1, meaning your company is worth $100M. So, you take your $100M home (minus the ~$15M capital gains tax, of course) and get ready to watch the magic as Warren dodges those taxes.
Much to your chagrin, nothing of the sort happens. Your company, now the property of Mr. Buffett, pays the same 35% tax rate as it did under you, and he pays the same ordinary income rate on any dividends that make it to his bank account. It turns out Buffett has been paying corporate taxes all along (using the roughly 20:1 P/E ratio of the S&P 500 and Buffett’s net worth of $50B, he’s paying about 50 / 20 * .35 = $875M a year at the corporate level alone); he only pays the lower tax rate on his realized capital gains. You shake your head, deeply disillusioned with Howell Raines, and use your millions to establish accounting scholarships all over the country in the hopes that others won’t make the same mistake. And you cancel your subscription to the NYT.
*(by education, not currently practicing)
Comments
9 responses to “Buffetted By Tax Myths”
Your company, now the property of Mr. Buffett, pays the same 35% tax rate as it did under you,
…except the interest expense incurred by Buffett when he “loaned” himself, rather Berkshire Hathaway, the $100 million to purchase your company. Should he charge BRK a nice 5% interest, then $5 million, or 1/2 of his new yearly corporate income is sheltered from corporate tax since up to 50% of income can be written off this way when “owners” lend money to their own corporations.
…except for all the income that is passed through in the form of health insurance for executives.
…except for certain other company expenses like maintenance of the corporate jet fleet.
…except for – well, you’re an accountant, you know all the schemes for tax avoidance, and if you don’t, then the corporate tax lawyers do. If Buffett plays this right, he might actually get some free money Washington for the purchase. Lots of possibilities there.
The effective tax rate, if averaged, for the top 500 corporations is about 17%. Defense related is less than 2%.
http://reclaimdemocracy.org/corporate_welfare/real_tax_rates_plummet.php
Of course, any is still double taxation.
If Buffett loans his holding company money, that’s ordinary interest income to him. In fact, if you loan the money interest-free, the IRS will impute the interest and force you to pay ordinary income rates on it.
Yes, corporate expenses are deductible.
Calculating “effective” tax rates involves so many judgment calls (property taxes, payroll taxes, VATs, sales taxes) that you can plausibly claim they’re anything between 10% and 50%. I do think there are too many subsidies, but they tend to be for things that people on the left like — farming, green energy, ethanol, low-income housing, etc. — so they’re hard to get rid of.
The point is this – if money is loaned by the principles of the business, the interest paid by the business to the owners, up to 50% of total corporate income, is a deductible expense and not taxed as corporate income.
It is just one among many methods of passing income through and avoiding the double taxation.
It will never happen, but all corporate taxes should be eliminated. As Sarah Palin said, it would end the corruption and put a stop to corporations buying off politicians in their efforts to circumvent onerous corporate taxes.
Can you imagine how much tax free capital could be accumulated this way, and the effect this would have in expanding businesses? It could lead to prosperity instead of the steady decline of our economy. And it will never happen. We are in the process of going just the opposite to a complete command economy.
Sure, it would lower corp income but raise personal. So the income is taxed at 35% (or whatever your personal marginal rate is) rather than the 57.75% combined you’d pay on income + dividends that made it to you. This is one of the ways our system doesn’t really make sense — but note that Buffett still pays a higher rate then his secretary here.
The problem with eliminating corporate taxes is that the agglomeration of millions of shareholders makes it impractical to assign corporate income to personal incomes. This leads to a lot of things that don’t really make sense and are basically deadweight losses, which is why we invented LLCs in the 1980s so that at least smaller companies could avoid all that.
If you don’t owe taxes, you haven’t pocketed any money.
Ah Yes, Taxation, don’ worry about the other guy, the more he can get away with now the more his estate will pay when he dies,
the government will get you but it will wait an=d get you worse!
I didn’t make myself clear. What I was suggesting, and I think Sarah Palin is thinking, is to apply income tax ONLY to dividends, while retained earnings are allowed to accumulate tax free.
The reasoning for this kind of tax holiday would be to help re-capitalize business. What we lack now is capital. With a few major exceptions like Apple, Microsoft, Exxon, etc. business growth and expansion is at the mercy of governments who soak up trillions in capital and remove it from productive uses. It isn’t just the taxes, but government intervention, or re-direction of money into useless enterprises like Solyndra.
I don’t think people realize just how difficult it is for a small business to save enough money to expand and hire when the more the owner makes, the more he is punished by ever increasing taxes. And in the current environment, the capital/credit is not there for him from normal channels.
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