Buffett talks sense on tax

Warren Buffett is back at it again.

Not content just to have a US tax policy known as the 'Buffett rule', the Berkshire Hathaway (NYSE: BRK-A, BRK-B) CEO has again called for higher taxes.

This time he has taken direct aim at one of the favourite defences used by those who don't want to see taxes raised – that higher tax acts as a disincentive to work harder or to risk your investment capital.

The case for lower taxes

The argument goes that lower tax rates mean you get to keep more of the overtime or the profits you make, thereby acting as an incentive to work harder and invest more. The opposite – that higher taxes mean you're less likely to do those things – is held also to be true.

Taken to its conclusion, a policy of lower taxation is argued to lead to more economic activity, more wages paid and profits earned, and therefore a more robust economy and society.

Buffett disagrees

It's safe to say Buffett doesn't agree. In a recent op-ed for the New York Times, Buffett took direct aim at that line of reasoning. On the subject of capital gains tax, he <wrote> (https://www.nytimes.com/2012/11/26/opinion/buffett-a-minimum-tax-for-the-wealthy.html):

"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 your reply possibly be this? "Well, it all depends on what my tax rate will be on the gain you're saying we're going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 per cent." Only in [conservative activist] Grover Norquist's imagination does such a response exist."

Obviously bank interest is higher here in Australia, but the concept holds – particularly given bank interest is taxed at a higher rate than long-term capital gains, and carries no franking credits.

Little evidence to support lower taxes

US capital gains tax rates have fluctuated considerably over the past half-century – from as high as 40% in the late 1970s to as low as 15% today.

Referring to the higher past rates, Buffett says:

"I was managing funds for investors then. Never did anyone mention taxes as a reason to forgo an investment opportunity that I offered."

He also points out that economic growth was strong when those rates were high. It's also hard to escape the reality that the immediate past has been poor for the stock market, just as CGT rates were at their lowest.

Of course, correlation isn't the same thing as causation, but it must at least call into question the view that lower rates are better for the economy. The evidence is shaky at best, and indicates the opposite at worst.

Turning his attention to personal taxes for the wealthy, Buffett again highlights the lack of evidence that lower taxes drive economic growth, specifically that during the periods of high marginal tax rates on very high income earners, the economy did very nicely. No evidence here to support the 'lower tax leads to prosperity' argument.

Of course, Buffett's comments have a real and immediate impact in the US, where Congress is debating how they close a big gap between taxes and government spending. There is a stark choice – reduce services or increase taxes. The answer is likely to be a combination of both.

Foolish takeaway

While it doesn't have the same immediacy here in Australia, the issue deserves consideration. None of us like to pay higher taxes, but as a society, we demand a certain level of services from our governments.

There are only so many cuts that can be made, and some of our infrastructure needs are significant – both economically and for the positive social impact they can have.

"In the meantime, maybe you'll run into someone with a terrific investment idea, who won't go forward with it because of the tax he would owe when it succeeds," Buffett writes. "Send him my way. Let me unburden him."

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