Watch What Warren Buffett Does, Not What He Says
Adam J. White
November 26, 2012 4:16 PM
Warren Buffett is by now no stranger to the national debate over federal tax policy. In 2009, he penned a New York Times op-ed calling for "truly major changes in both taxes and outlays." Two years later, he returned to the Times with a widely publicized call
for large tax increases on the "super-rich," noting that his own
effective federal tax rate (17 percent) was far less than his employees'
rates (ranging from 33 to 41 percent). President Obama liked the idea
so much, he called for Congress to pass "the Buffett Rule" in his 2012 state of the union address.
Given that long, well-publicized history, there isn't much news to be found in Buffett's latest Times op-ed this morning, calling once again
for a minimum tax on millionaires. Except that Buffett opens this one
with a rifle shot at Grover Norquist specifically, and supply-side
economics generally:
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 percent.” Only in Grover Norquist’s imagination does such a response exist.
It's a catchy opener, attracting headlines and guffaws from
the expected quarters. But I'm struck by his opener because I can think
of at least one real-world example in which a rich investor nearly
spiked a deal due to taxes: Warren Buffett himself, as recounted in
Alice Schroeder's terrific biography, The Snowball (pages 230-232).
Early in his career, Buffett invested
heavily—almost one third of his early fund's capital—in Sanborn Map, a
company that mapped utility lines and such. But he soon grew frustrated
with the company's leadership, which "operated more like a club than a
business," and which refused to return greater dividends to
investors. So Buffett amassed more and more stock, and with control of
the company finally in hand he pressed the board of directors to split
the company in two (one for the mapping business, and one to hold the
company's other outsized investments).
Finally, the board capitulated. But with victory
finally at hand, Buffett nearly scuttled the deal because of ... taxes.
As Schroeder recounts, quoting Buffett, one director proposed that the
company just cleanly break the company, despite the tax
consequences—"let's just swallow the tax," he suggested.
To which Buffett replied (as he recounted to Schroeder):
And I said, 'Wait a minute. Let's -- "Let's" is a contraction. It means "let us." But who is this us? If everyone around the table wants to do it per capita, that's fine, but if you want to do it in a ratio of shares owned, and you get ten shares' worth of tax and I get twenty-four thousand shares' worth, forget it.'
Buffett was willing to walk away from a deal
because the taxes would have taken too much of a bite out of it.
Fortunately for him, the board gave in and allowed him to structure the
deal that he liked, saving him from his own Norquistian response.
That's not the only time that taxes played a major role on Buffett's decisions, as recounted by Schroeder. Later in the book (pp. 533-534),
she recounts how Buffett chose to structure his investments under
Berkshire Hathaway's corporate umbrella, rather than as part of his
hedge fund's general portfolio, precisely because of the tax advantages.
In fact, as he explained in his 1986 letter to investors, changes in the 1986 tax reform act posed a specific threat to certain investment decisions:
If Berkshire, for example, were to be liquidated - which it most certainly won’t be -- shareholders would, under the new law, receive far less from the sales of our properties than they would have if the properties had been sold in the past, assuming identical prices in each sale. Though this outcome is theoretical in our case, the change in the law will very materially affect many companies. Therefore, it also affects our evaluations of prospective investments. Take, for example, producing oil and gas businesses, selected media companies, real estate companies, etc. that might wish to sell out. The values that their shareholders can realize are likely to be significantly reduced simply because the General Utilities Doctrine has been repealed - though the companies’ operating economics will not have changed adversely at all. My impression is that this important change in the law has not yet been fully comprehended by either investors or managers.
That last point is key: When taxes change, would-be
investors will certainly change their decisions about where to direct
capital, even "though the companies' operating economics will not have
changed adversely at all." Buffett saw this clearly in 1986, with
respect to Berkshire's own investment decisions; it's hard to believe
that Buffett no longer believes that today, with respect to private
investors.
Now, none of this is to say that the
capital-allocation effects of tax changes ultimately require the nation
to forego tax reforms that would increase certain tax revenues. But it
certainly is one consideration that must be kept in mind. When Buffett
and others simply assert that tax increases don't affect investment
decisions, they're whistling past the graveyard.
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