Is Warren Buffett Smart?

By Son of Bastiat

“Financial genius is before the Fall” - John Kenneth Galbraith

Almost by universal acclaim, the answer would have to be a resounding Yes! For how else would it be responded to except affirmatively, based on what “popular wisdom” knows and says about the man:

a.  The world’s second or third wealthiest man (only Slim and Gates are wealthier according to Forbes). Better yet he found his way there through patient value digging, not market rigging

b.  A lot of this wealth is in liquid form, being shares in large, established publicly traded companies

c.  Unlike Gates or Slim whose wealth are tied up in narrow sectors (telecom, software) Buffett’s wealth is diversified across sectors that the first two wealthiest men can only dream of.

So, from the narrow standpoint of investment quality, Buffet is not only smart but astute in ways that the other two aren’t. The real question is: How does his “smartness” fair outside of this narrow area?

Probably Not As Smart As Supposed

We’re not talking about his stock picking abilities which based on his mistakes in later years have not been as legendary or exceptional as the ten baggers (like Coke, W. Post or Geico) of his early years in the stock market. We are also not referring to his mediocre currency derivative bets that turned out poorly (disclosed in the Annual B-H Shareholders’ Letter) that luckily got offset by spectacular stock futures option trades (from hedge fund gossip) which tells those who know how these markets work, that his prowess is now based more on selecting the right stock options traders and managers than any innate value creating abilities unlike during his early stock picking career. In fairness to the man, he eschews esoteric investment ideas beyond the OPT so he does not invest and hence eats the kind of losses that reckless hedge fund traders do with loads of chutzpah. This Graham disciple remains so today despite the fact that very volatile markets are not kind to value investors.

No, we are here talking about the fact that outside of his stock-picking (and manager’s selecting) skills, the man is a complete novice, if not a dodo in the larger economic environment of which investing is a tiny part. This is based on only one, but a very central aspect of that reality, the question of what taxes ought to be paid by people like him. As explained below, it reveals a lot about whether his smarts are innate or merely of the acquired kind. None of this is to denigrate businessmen the way enemies do.

The First signs of Cluelessness

Buffett has for years been quoted as saying that the rich are getting off from their obligation to pay a fairer share of the nation’s tax burden. Last July 7, in a series of interviews that the liberal media quickly picked up and disseminated (for a reason), he said that “I think the rich have a responsibility to pay higher taxes” followed by a statement that his wealthy friends “are paying lower taxes than the people who are serving the food” after an earlier disclosure that his personal tax rate was a mere 17.7 % compared to that of his receptionist of 30 %.

All these populist sounding nonsense fitted in so well with one of the left’s most durable and cherished myths, which is a war among classes, down to the fact that they are mostly wrong:

a.  Effective Tax Rates. From 2008 data supplied by the IRS itself, the share of Federal taxes in household income after deductions and exemptions amounted to 23.3 % for the top 1 % of all household income earners (above $ 380,000); 19 % for the top 10 % of household income earners (above 114,000); and 22.7 % for the top 0.1 % of household income earners ($ 2 MM and above). Contrast this with the 4 % paid by median income households ($ 35,000 and above), or the high, negative effective taxes paid by almost 60 % of all households who either receive incomes too low to be taxed, and/or receive some form of public assistance and entitlement. Talk about equity.

b.  Total Federal Tax Rates. Based on CBO data, the share of total Federal taxes (not just on income but on Social Security and Medicare payroll taxes) paid by middle class families ($ 34-50 thousand bracket) was 14.3 % of income, versus the 27.9 % and 29.5 % paid by the top 1 % and 5 % of all tax payers. Or the 32 % of all Federal taxes paid by the highest income earners. The reader is invited to calculate Gini concentration coefficients to show that these tax rates are indeed progressive.

c.  Effective Tax Rates After Considering the Source. In a 2010 IRS limited study of the taxes paid by a sample of 400 of the nation’s richest personal tax payers, the effective share of taxes to reported- income came to about 18 %. This is the study that Buffett probably referred to, as he would most likely have been one of those 400. Except that most if not all of these tax payers derived their income from investments, meaning that they reported incomes that had been taxed twice, either at the level of dividends (35 % on ordinary income) and capital gains (15 %) for a total tax burden closer to 45 % and not the 18 % that came out from the simplistic division of two numbers. Quite definitely not the level of expertise expected from a seasoned financial analyst like Buffett.

d.  Shelters, Loopholes and Tax Base Reduction Gimmicks. Buffett’s claims would have been more morally defensible had he eschewed the usual gimmicks used by the wealthy to reduce their basis and not just the incomes they were free to report (or defer to a lower tax rate phase in their lives as is commonly done). Buffett is being facetious in comparing his after tax position vis a vis the middle income classes for three reasons: as a wealthy tax payer he is able to take advantage of the tax shielding allowed on donations to charitable causes; he is able to effectively reduce his taxable base by booking most of his income as “carried interest” 20 % of which he can later pay taxes on under a favorable 15 %; and most outrageously of all, with the bulk of his assets already donated to a foundation, he is able to shield them from the high taxes during distribution. These tax preferences for the wealthy the middle income classes can only drool of, but which of course Buffett neither mentions in the same interviews, nor corrects on his own, if he was that convinced of its injustice, by just quietly writing a check for the underpayment towards the right tax amount.

More Evidence of Poor Smarts

If Mr. Buffett was really that smart (not just an astute investor and businessman) he would have figured out in ten minutes why a tax policy based on such idiosyncratic assumptions (ie, provided they were empirically right, which they aren’t), would eventually to the destruction of the very wealth that he along with millions of entrepreneurs labored so hard to create:

a.  Taxes have behavioral, not just fiscal impacts as any simpleton understands. Regional tax data reveal that states with low taxes attract rich and even middle income tax payers away from the high tax states and indeed explains the erosion in tax bases of such states as California and Wisconsin and the surge in tax receipts in tax advantaged states like Texas and Florida

b.  Ditto, but with even worse consequences when US wide data about rich tax filers are taken to consideration. In a study recently released by the IRS, it was found out that the number of rich tax filers shrunk 39 % between 2009 and 2010, representing a 42 % decline in tax receipts over the same period. The favorite explanation is of course the recession, but the really “smart” folks know the true reason, unfortunately they will be apocryphal tales for now until proven otherwise.

c.  Not just that “billionaires and millionaires” ceased to exist, but that those who stayed put in their respective domiciles, apparently indulged in less economically rewarding activities just exactly as predicted by the famous Laffer Curve (a backward looping effort vs. tax rate curve posited by the Chicago economist A. Laffer). A sample of b respondents should easily verify this. These data are not harbingers of the business climate that nurture future successes like him unless he wants it.

Given this obvious conclusion, Buffett’s plea to be assessed a higher tax can’t be viewed any other way than that he is not being smart. As far as can be seen, he is not an ideologue, or a Democratic partisan, and because he is too mature to play the sort of political games indulged in by folks like Obama, he must be pretty dumb to entertain and spouse these views. Ironically it was Galbraith, a liberal economist, who said that smart (finance) people tend to get dumb before they fall. Could he been thinking of W. Buffett?

Concluding Comments

Which brings us to the core question: Why is the liberal class making hay out of these nonsensical ideas (which they have to be dumb to even consider, unless they haul their worn out pleas for fairness-at-all costs)? The answer, once again, is simply this: by shaming the rich into agreeing to pay a higher fraction of their incomes, the path is clear to coercing the middle classes into paying higher taxes.

The fact is that 3.2 million middle income households earning above $ 200,000 paid $434 billion in 2009 taxes, the rich revenue lode that liberals like Obama, checkmated in their borrowing plans by conservatives have been eyeing to grab at all costs. Read that again: At All Costs, meaning, no matter if these folks will flee and take jobs along with them, and regardless of whether the outcome is fair as they like to loudly proclaim.

It is the very imbecility of this idea that has turned off the author from the liberal agenda, realizing that what they are about is mostly Big Government programs that everywhere has bankrupted countries and states.

None of these excuse Americans from having to pay higher taxes eventually, if only because of the mistakes committed by the politicians they have elected previously. But such policy decisions have to be done smartly, or else automatically (like what the author has advocated along the lines of Miller’s The 2 % Solution idea wherein a set portion of the nation’s output is set aside from welfare and social spending) to eliminate these kinds of politically abhorrent decisions that turn folks like Buffett into big disappointments especially in their twilight years. [Copyrights: The Son of Bastiat, VRR@NYC2011]  

Why Not Put Welfare on Auto-Pilot?

“Plus ca change, plus c’est la meme chose” – French for “something’s got to give”
By Vincent Ricasio

Yesterday’s devastating 260 points decline in the Dow, the 7^th or 8^th consecutive drop in as many days, an event which has had no precedent since 1987, despite (or perhaps because of) the president’s signing into law of the debt ceiling increase negotiated last weekend by both houses of Congress, is a portent that things are not going well on the economic front. Many pundits have, of course, have said as much right after the Senate voted on the amended version of the House Bill, but their arguments were more focused on the impacts of the new law on the deficit, and, through that, on job creation, wedded as most of them are to the discredited Keynesian prescription of using government spending to stimulate economic growth, in contrast to the less known but more insightful debt-deflation theories proposed by the Yale economist I. Fisher and F. Machlup, which requires “real” economics to bow down to the “veil”, a not very pleasant prospect for many economists who to this day still dismiss finance as economics "on stilts"

Well, not only has the evidence shattering that myth come again 70 years after the New Deal (the sorry job creation record post TARP II, the $ 787 B stimulus blowout, the mortgage write downs, the cash-for-clunkers and the extension of unemployment insurance, etc.) but there are again rumblings of a second contraction, a reprise of the earlier massive 3.3 million job elimination that more careful studies of the past century’s FINANCIALLY triggered recessions always seem to bring about once the stimulus is stopped, somewhat akin to the catharsis that drug withdrawal brings about. This coming recession is evidence that the markets are discounting the impact of the debt ceiling agreement, seeing ahead of the curve, the dysfunction that interventionist fiscal policies have never overcome, in the form of timing errors that always bedevil all attempts to “beat the cycle”. Unfortunately the lessons are always painful, borne not by the economists who deftly bailed out of this administration as soon as they saw the writing on the wall, but by the millions of workers who will lose jobs, again, not only in the US but abroad. As if it was not enough devastation.

Which brings me to the real purpose of this brief memo: If based on the recent debt ceiling debates, it doesn’t seem any more possible that political consensus can pacify people’s (which is what markets are made up of) unease about settling the great debate between liberals and conservatives on what to do with social spending, then why not do the second best – fully disclosed policies and rules, agreed to beforehand by both sides, as to the amount and composition of government spending on such things as welfare and entitlement? This way the room for maneuver is known if not with full certainty then at least with some allowance as to timing, the uncertainty which spooks markets the most. Compare this to the current practice wherein politicians, always with an eye to their future electoral prospects, posture and preen before their respective bases, which in turn excite the extremists on both sides, making real consensus all but impossible. The only reason the debt ceiling debate turned out the way it did, despite the fact that conservatives were the minority in this tri-partite government, is because the negotiators were aware that slowing down government spending was what the Nov. 2010 elections was all about. You wouldn't hear that from the commentariat/blogsphere.

But look at what the “agreement” cost America: other than a no-tax increase provision, all that the law accomplished was a one time spending cut that stretches over ten years, to be matched by pledges to cut some more based on the recommendations of a bipartisan commission. Anyone who understands how DC defines budget “cuts” and has a modicum of knowledge of their unique syntax knows that commissions are mere ploys to defer hard decisions past elections. The $ 2.3 T increase in the debt ceiling was meaningless, both because it is just an imaginary line-in-the-sand that will be increased, again and again once the deficits roll in as they will. And besides the credit raters won’t base their downgrades on such an inchoate variable, knowing full well that nothing real was done on the cause of the deficits and aware that the US has long breached its “mental” debt ceiling. So what was the point about the law? Exactly this: to keep this radioactive (but symbolic) topic away from public consciousness until at least 2013, a year after the elections. So, in that sense, President Obama the ineffective leader that he was shown to be, still managed to win. If you think the conservatives will abide by that, there is a bridge for sale on the East River. It will be business as usual in a while.

So what will a welfare policy “on autopilot” do? Answer: it will take away (or at least reduce) from politicians their power to tinker around with social policies as a vehicle to enhance electoral chances by manipulating the poor and even the not-so-poor (who thrive on the social largesse). A policy that, say, sets down public spending on social programs at a preset level (absolute + some amount that varies based on a GDP above a certain level, etc) will take a lot of the ideological hot air, acrimony and moral posturing that keep radicals on both sides agitated for nothing. One need not revisit that largely, ugly, unresolvable debate: the liberals, on the one side, accusing the right of callousness and lack of concern for the poor; and conservatives charging liberals of being patsies for the institutions and vested interests that thrive on the poverty cottage industry. The fact is that they both deserve each other as excuses for their not acting more responsibly: the conservatives for lacking in moral conscience, and liberals for advocating woozy policies that respect no limits and suffer from slippery slope inadequacies.

For economists, the details are mind boggling (what social policy isn’t) but instead of wasting their time debating whether Keynesian multipliers are 2 or 0 (or even -1), they could be more socially useful in helping design these practical rules. One particular issue they will have to address is whether “rules” could exacerbate cyclical imbalances, although automatic stabilizers do work to correct it without the discretion that bedevils human interferences in the economy. Over the longer run, nothing short of a truly radical restructuring of the economy would be needed, along the lines propounded by economists like B. Hodgkinson and others, where the “rich landowners” (proxy for unearned income and other privileges accrued merely for being present when the goodies were distributed), would be assessed for their social tuitions to fund welfare, which also reduces policy discretion and leeway for agitation. Here is where liberals are correct in essence, but wrong in tactics (if only because they still lost the debate).

Such questions are a worthy of the best minds to address, for the status quo is simply too terrifying to contemplate: the three top items in US social spending (Medicare and Medicaid and repaying Social Security) would, unless something truly radical was done, eat up as much as 70 % of the US government budget in about two decades. That guarantees that every time America enters through another serious fiscal dysfunction, the economic health of the world would be in grave peril. And all due to unresolved inner conflicts that show up as political hostilities? Why punish the rest of the world for US government dysfunction? People who still think that that debate in DC was about politics do not understand the real causes here: Read my lips, cut government down!

In a way this is really sad, to have to use “formulas” and “rules” to handle what ideally should be dealt with using natural human empathy for others and restraints on uncontrolled passions. But this is man as he has become now, and until religion has returned to its true function in society as Jung once pointed out, these solutions will be mere stop gaps that will blow up again and again. Or maybe that’s part of the Plan. 

[V. Ricasio, copyrights NYC2011]