richest people in the worldTaxes are always a heated subject. Some rich feel it is unfair to pay more money for earning more. while many poor, and middle class people think that the rich can afford to pay higher taxes far easier than themselves. Ironically, many ultra-rich people pay lower tax rates than middle class or poor Americans. Warren Buffett is the perfect example.

Warren Buffett stated  in 2006 (and has repeated the state similar times) that he paid an income tax of 15.5% on his income of $46 million while his secretary paid 30% as tax on her $60,000 income. He mentioned that a few of his friends calculated and compared their percentage of taxes with that of their lower level employees and the same conclusion was reached: the US tax system allows the rich to pay less than the poor, which further widens the income disparity among the rich and the poor. Buffett, while slamming the tax system, suggested the US government take appropriate measures and increase the tax rate for the high income groups.

However, there is more to the subject of the US tax system than that highlighted by Warren Buffet. Before getting into further details, it is essential to highlight few aspects of the US tax system. In contrast to what is said by Buffett, the tax system taxes individuals in the top income bracket  at a rate of 35%. This leads us to the question of how Warren Buffet, the third richest man as ranked by Forbes, ended up with a 17.7% income tax rate on an income of $46 million? Most of Warren Buffett’s income comes from capital gains and corporate dividends, thus, he is liable to a tax rate of approximately 15%. The reason why capital gains tax rate is almost half of that of the normal income tax rate is to encourage investment in businesses which, ultimately paves way for job creation. Capital gains from long-term investments are taxed lower than the capital gains from short-term investments, which encourages long term investments as opposed to speculative trades. Anyone who is familiar with Warren Buffett knows that his investment philosophy is to invest in good companies on a long, and sometimes very-long, term basis.

I think it is ridiculous for the rich individuals, like Warren Buffett, Mark Zuckerberg and Bill Gates to call for higher tax rates. All of the above have most of their cash tied up in long-term investments, generated through capital gains and dividends and pay only the capital gains tax of around 15%. Perhaps the only reason they are in favor of  increasing the income tax rate is because it does not impact them; if they are so concerned about paying a fair share of tax what they should be suggesting is an increase in capital gain tax rate.

The capital gains tax was not so low until the 1990’s; it was 28%. Bill Clinton decreased it to 20% during his presidency, and later George W. Bush further reduced the rate to the current 15%. There have been considerations of increasing the capital gains to 20% by the Obama administration, which would add up to $12 billion in Treasury in 2014 after its implementation.

Taxes on capital gains and dividends are really double taxation.  The corporation pays taxes, and then the stockholder (who is an owner of the corporation) pays taxes again when he/she sells their shares. It is especially unfair for dividends since they are taxed regardless of whether there is a sale or not. However, this is not the topic of the article, nor am I saying that capital gain or dividend taxes should be reduced or eliminated. Although, I would be in favor of a lower rate on dividends since it would encourage companies to payout more and be more shareholder friendlu.

It should also be noted that for Buffett who is valued at more than $50 billion, the taxable income of Buffett is merely $46 million (0.1% of his estimated value). The matter of fact is that his true income is not his taxable income due to the investment and income generating methods adopted by Buffett. He invests in stocks of good companies for long-term basis , he avoid realization of capital gains, he avoids tax on capital gains by giving to charity the appreciated assets, and lastly he has tax-free municipal bonds making some portion of his total portfolio. Thus, the increase in capital gains tax or income tax rates would barely result in an absolutely fair taxing system as the tax rate would only be on the taxable income of the rich, which usually is manipulated using various loopholes and tax savvy strategies, and not their true income. I doubt Buffett would ever propose a tax on assets, as is done in Switzerland.

I have tremendous respect for Warren Buffett as an individual and as an investor. He is arguably the best investor ever, and he is donating the vast majority of his wealth to charity. However, no one is perfect, and I am just pointing out one topic, which I feel Buffett is a bit of a hypocrite on.

 

Disclosure: No position in Berkshire Hathaway