An op-ed piece by Warren Buffett appeared in the New York Times on Monday August 15th. As a multiple decade follower of Mr. Buffett and his partner Charles Munger, and a dedicated reader of Buffett’s letters to Berkshire Hathaway shareholders, it was to say the least, a fascinating series of contradictions.
The first Buffett statement that struck us as strange was this one: “While the poor and middle class fight for us in Afghanistan…..” We are mindful of the fact that many Americans feel our government should not be involved in Afghanistan, Iraq, and Libya, not to mention removing tens of thousands of troops stationed in other places. Many believe there are many policies that can keep America safe at a much lower cost, both in terms of blood and treasure.
Next Buffett opines as follows: “Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.” This statement indicates that most of Buffett’s income was produced by capital gains earned on dollars that had already been taxed at least once.
Buffett adds, “If you make money with money, as some of my super-rich friends do, your percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine — most likely by a lot.” In using the term, “making money with money,” Buffett is defining a process that provides precious seed capital. Capital deployment creates jobs. There is nothing wrong and everything right about structuring incentives that result in the forming and deployment of capital. In fact, this incentive is preferable to incentives for consumption, especially in the long run. Our problem is not investors earning returns that are too high. It is that they are earning returns that are too low.
Buffett confuses the issues for the reader when he says: “To understand why, you need to examine the sources of government revenue.” Most people understand the revenue “sources,” but not everyone understands the incentive structures that control government revenue sources. Charlie Munger teaches us that the proper structuring of incentives is the key to management. Producing the desired behavior requires a careful consideration of incentives according to Charlie.
Buffett inadvertently explains the flawed incentive structure of government revenues as follows: “Last year about 80 percent of these revenues [the government’s] came from personal income taxes and payroll taxes.” Again, it is critical to recognize that since 51% of all households do not participate in the cost of their government by contributing income taxes, there is insufficient incentive in society for cost-cutting.
Ironically, Buffett has written volumes on the importance of “cost cutting.” Apparently, the only exception Buffett has for writing about the importance of controlling costs is when attempts are made to apply this crucial principle to government. It is also extraordinarily important to point out that in America, payroll tax collections are not escrowed and segregated in retirement accounts as intended by the social security program when it was established. We will continue with part II of this series tomorrow.