txlaw

Margin of Safety is a great book, and Klarman is one of the best. But I don't think Klarman is as good as Berkowitz is at analyzing businesses.

Wow, that's quite a pessimistic assessment of Berkowitz. Let me address a couple of your comments. Nearly inconceivable invicible status; media, media, and more media -- Not sure this is the case. His exposure has definitely skyrocketed, but I don't think people think he is invincible. On the contrary, everyone appears to believe he is crazy for picks like AIG, MBIA, and JOE. If you think it's a bad idea for him to appear so frequently in the spotlight, I would suggest that this has been helpful to FAIRX shareholders, who get a better understanding of the rationale behind his investments -- if they read between the lines. More funds; size going parabolic -- Yup. No question that this will affect how he can deploy capital, but I still expect that he can achieve at least low teen returns over time with his current AUM. His investment mind is one of the best out there. He's one of the few people who can practice focus investing on par with the best, but he can't really be that focused running a mutual fund. Successful bunch of the support staff left -- This concerned me as well, and I still haven't gotten a good answer about whether they left on good or bad terms. On the one hand, the name of the new group (GoodHaven) could be a good sign, indicating that they are spin offs, sort of like the Tiger Cubs. On the other hand, perhaps they left for other reasons that are not so good. I wish someone in the know would chime in here. Escaping to the hot summer cold winter Florida panhandle via a trust fund for insiders (St. Joe) -- ??? Could you please elaborate on your theory here? Citing government as a reliable investigator analyzer of business -- I believe the point Berkowitz is making is that the government has had the opportunity to audit many of the black box financials that are now in the portfolio and that it is very unlikely that these companies would have been taken off life support if government officials did not believe that the capital positions of these still TBTF companies were now okay compared to during the financial crisis.

I really like James Montier. Thanks for posting.

You get last words. People must be getting really sick of this thread.

Don't know how you saw that implicitly. I keep talking about how to tax realized income, given that we have an income tax, rather than keeping people from compounding their wealth over time. I won't have to grit my teeth at all about the tax code being the primary culprit between the growing disparity between people at the top and everyone else. There are other reasons that are far more important. I think we see eye to eye on this issue. In my earlier posts about the consumption/wealth tax, I said that it didn't really make sense that the "working rich" should be penalized compared to the "idle rich" for their consumption. In a world where we have an income tax rather than a consumption tax, perhaps we should be thinking about ability to consume and take household balance sheet into account when determining at what rates income should be taxed. I didn't advocate a tax placed annually on the balance sheet. I thought it might be a good idea to have a cash flow consumption tax that would have tax rates based on the balance sheet. So if a super rich individual uses $200K of funds for consumption, he would pay a tax on that $200K that is based on his balance sheet. He may indeed have to sell down shares of a holding company vehicle if he's not liquid enough to pay the tax. Admittedly, though, I haven't thought much about how such a tax would be administered. In fact, I believe I mentioned that it would be difficult to actually do that. And I'm sure there many other problems that I'm not thinking of. That's why these issues are so hard. No I certainly don't believe that. However I did joke about it -- you can probably search for the word "jokingly" and you'll find the specific sentence. But I'll save you the time: Cynically, I would jokingly suggest that they've lobbied to have that personal dividend tax put in there just to convince double-dividend-tax-conscious people like you to give them a lower corporate dividend rate within the holding company so they can grow dynastic wealth faster. Okay, I may have mischaracterized your stance. That's fair. I will note once again, though, that my focus is on how to tax realized income because realized income can be used for consumption.

Don't forget who you are talking to... just a few posts back I explained that one really needs to acquire a controlling stake in an existing company in order to make buybacks work for tax laundering. To jog your memory, I was referring to why starting my own C corp doesn't work. Pick 60% ownership if that suits you... just don't jump all the way to "wholly owned" -- I didn't. Yes, I said "acquire a holding company", but I figured you'd understand what I meant... I would have not said the word "acquire" otherwise, for it would be far simpler to just start a new C corp (were it not for the dividend laundering thing). Perhaps you are just screwing with me... maybe I should stop taking the bait? I didn't forget. I actually thought you were screwing with me with those two scenarios you described. With your buyback scenario, where you own 60% of the company at an average cost of $100 per share, either the buyback is cashing you out of your ownership stake or cashing out the nonrelated shareholders. If the buyback is cashing you out of your ownership stake at $200 per share, you get $200 cash for each share you own, resulting in a tax liability of $35 per share. But you also give up the economic rights associated with each share you sell for cancellation. If intrinsic value (IV) is $200 per share (remember, ideal world), you give up IV of $200 for each share you sell. On the other hand, if there is a dividend of $200 per share, your shares are now worth $0 (IV of $200 minus $200 dividend) and you have realized $200 of income per share, $100 of which can be offset by selling all your shares for a $100 loss per share. Same tax liability of $35 per share. Only when buybacks are at greater than or lower than IV prices (non-ideal world) do you get different economic results. Am I wrong about this? If you provide more detailed hypotheticals, you can show me how I am wrong.

Interesting article. http://www.nytimes.com/2011/03/05/your-money/05money.html?pagewanted=1&hpw

Letter to Employees: http://www.sec.gov/Archives/edgar/data/745308/000095012311022239/b85418exv99w1.htm Local article about defense industry focus for JOE: http://www.waltonsun.com/news/focus-91439-newsherald-industry-joe.html

I liked that part as well!

That's half the truth and I'll show you why. I will use the same tax rate in both scenarios. Scenario A: 1) You acquire a holding company for $100 per share 2) It buys back shares at $200 3) You pay just $35 in tax Scenario B: 1) $200 dividend is paid out 2) You pay $70 in tax Twice as much tax!!!! Well, now we come back full circle to what started this post. Let me add some detail to your scenarios. The holding company has assets consisting of $400 cash and liabilities consisting of $200 debt at a 0% real interest rate. There are 2 shares outstanding. Therefore, each share lays claim to $100 of equity in the holding company. Ericopoly's Scenario A: -You acquire both shares of the holding company at $100 per share. -You attempt to buy back 1 share at $200 per share for cancellation, using $200 of cash on the balance sheet. -You realize that because you already own the entire holding company, the tax code won't let you treat a buy back from one's self as a legitimate transaction. Nice try, though! Ericopoly's Scenario B: -You acquire both shares of the holding company at $100 per share. -You dividend $200 of cash out ($100 per share), resulting in a total tax liability of $70 to you. txlaw's Scenario C: -You acquire 1 share of the company at $100 per share. Some other guy owns the other share of the company. -You convince the other guy to let you buy back his share at $200 per share because you're convinced that you'll come out ahead because of the tax savings. -The other guy receives $200 for his share, which is cancelled. Assets: $200. Liabilities $200. -Congratulations! You now own 100% of the company (only 1 share outstanding) that lays claim on equity of $0.

You have been naively arguing that the taxes will be collected on the personal income tax return as distributions are paid out. That's true for people who don't have a ton of money already and who therefore need liquid funds, but it's not true of the very rich. They use them differently from how you envision -- they are effectively just an investment account that has a much lower tax rate -- and the tax rate can be driven to zero as they achieve scale. And that's pretty much what we disagree about. I am having a conversation about how the very rich use it as a tax shelter, and you are justifying the tax shelter by saying that the much smaller people take distributions and pay the tax. Wrong. I never argued that. In fact, from my posts about a consumption/wealth tax, you should be able to infer that I am well aware that very rich people never need to realize income and can keep growing most of their wealth tax free. What we disagree about is the rationale for taxing realized income (although you keep equating all dividends with realized income). You believe that the way we tax dividends/realized income is a result of the super rich protecting their own interests. I believe that the rationale for taxing realized income is because cash in the hand can be used either for consumption or investment, and we generally want to encourage investment and take a cut of consumption. In other words, keeping capital deployed in investments is encouraged by the tax code, and the tax code by default assumes that all realized income will be used for consumption. Progressive income tax rates and tax-deferred/tax-free investment vehicles mitigate the effects of this default by recognizing that the first dollars of annual consumption shouldn’t be penalized versus investment. I don't try to justify any "tax shelters." You're the one who is obsessed with avoiding taxes.

For whatever reason I didn't see this paragraph the other day. I think I only saw the next successive post. There is little reason to be concerned about triple taxation, LOL, for often not even double taxation occurs because these guys can compound most of their assets in these corporations and the step up in cost basis happens upon their death. So they acquire a company whole, and pay only the corporate income tax. They reinvest the profits from one business to buy the next, totally free of dividend tax. This goes on for decades, and then whoever gets their shares upon death has the step-up in basis and can cash out free of taxes. Can you name a single family that has liquidated and paid out all dividends just to be "fair" to society when on their death bed? That's just not realistic, not even Buffett intends to write any check to the IRS -- it's all going to be free from tax. He will give most of it to the Gates Foundation which is a noble thing and they will help a lot of people around the world, but it's not going to help his secretary with her tax bill. You keep talking about this extra layer of taxation as if a very rich person is actually going to pay it! So you justify their lower tax rate based on the extra layer that never gets triggered. Cynically, I would jokingly suggest that they've lobbied to have that personal dividend tax put in there just to convince double-dividend-tax-conscious people like you to give them a lower corporate dividend rate within the holding company so they can grow dynastic wealth faster. Let's propose an investment structure for the rest of us... okay, how about a special kind of investment account that compounds completely tax free but has a 99% tax on any gains extracted. Then put a rule in there that says upon death the account can be liquidated by the heirs free of tax. I might sucker a few voters into passing such a bill, then I'd use it as a vehicle to compound wealth faster that I intend to pass on to the next generation. You have to stop and think for a minute why I am so impressed with that structure -- yet at the same time I hate paying taxes. There must be something I am seeing that you are not, and now I've layed it out there for you. I read your posts and thus far you've never mentioned the "loophole" that is the step up in basis, which completely obliterates that extra layer of taxation. As long as they have enough money (hundreds of millions) of family money outside of the holding company, they can comfortably lock up their remaining tens of billions within the holding company -- and their families never pay that tax as it passes to their heirs with step-up in basis. Or they leave it to charity... but again, somebody still needs to pay the bill to the IRS, so who are they going to come after? Some of these charities are outside the country, which is terrific for the recipients, but it still leaves open the question of who is going to pay the domestic tax bill? Even in the unlikely event that they do one day liquidate one of these holding companies -- they've had decades of dividend-tax-deferred benefit so a one-time dividend tax on liquidation would be wholly inadequate in terms of recapturing the lost taxation. Pennies on the dollar. If you don't agree, then think about the reason why we like to use IRA accounts for tax-deferred compounding. Let's put it this way, because I think this is a fact we can agree on -- every time Berkshire makes a large wholly-owned acquisition the IRS stops getting dividend tax checks from the prior shareholders. Does the government cut spending to make up for this? Who do you suppose is going to pick up the tab? These are dividend-tax-deferred compounding vehicles only if dividends are actually paid out -- they are dividend-tax-exempt if held until death for passing to heirs. Once again, you've missed the distinction between dividends and realized income, as well as the whole point of this debate, which was about the corporate tax rate and the tax treatment of dividends, not the ability to avoid taxes through estate planning. To quote my original statement about the corporate tax rate: “I'm speculating, but I would guess [buffett] thinks the corporate tax rate should be lower because any income not distributed to shareholders or employees will be reinvested into the business or into other businesses. It's a question of taxing investment versus consumption (or potential consumption) .” [Aside: I actually made a mistake there. Any cash distributed to employees is actually an expense that occurs before calculating corporate income.] Additionally, I said: “If the individual controlling the investment holding corporation wishes to use the investee corporation's earnings for personal consumption, he must either dividend the earnings out to himself, incurring double taxation on the resulting individual ordinary income, or sell part of his stake in the investment holding corporation, incurring double taxation on the individual capital gains.” True, the step-up basis rule provides a way for an individual to avoid paying capital gains on his appreciated property. But the key to that is the guy has to have died without realizing any of that income! His incentive is to keep reinvesting profits into his various businesses rather than realizing income for consumption so that his heirs will get his appreciated property tax free. You seem to have lost the point I was making while you were crafting your tirade about the super rich oppressing the merely rich. (Cry me a river.) Should there be a step-up basis rule? Hell no, there shouldn’t! There also shouldn’t be other work arounds like trusts and other vehicles that allow wealthy people to hire tax/estate planning lawyers to avoid taxes. We also need to keep the estate tax, or the “death tax” as people against it would call it. I’m very much against dynastic wealth. And the way that rich people can plan their estates and increase wealth on a tax-advantaged basis through investment rather than labor drives me crazy. But absolutely nothing you've said convinces me that you are right about corporate tax rates and how we tax dividends. I did not know about that particular distinction in the tax code, but it makes sense to me. The tax advantage you describe comes from the capital gains rates and from the fact that you would essentially be buying back shares from yourself, which would be absurd. The rule makes sense because you really should be cashing out non-related shareholders for a new cost basis, not a tax loss. I fully support taxing capital gains as ordinary income! And so does Buffett. In the ideal world, there would be no reason for “dividend laundering” because the capital gains rate and the ordinary income rates would be the same.

Hmm, maybe he'll use those Energy Future Holding bonds to establish Berkshire as a front runner to buy up the company. That would certainly be an elephant.

Very exciting. I'm looking forward to buying back in before/when the insurance cycle turns.

I really like your trust plan, Eric. Shows that your kids will be alright despite having Dad always being around all the time :) My thing about the household balance sheet-oriented consumption tax is that I actually think it's rather unfair that some guy (or gal) who works hard, spends most of his income/wealth on servicing/paying down student loans, paying bills, paying the mortgage, and raising (not spoiling) the kids, but who has very little net worth would have a high percentage of his cash outflow taken out by the government versus some guy who starts out on third base in terms of wealth, doesn't spend that much on annual basis, but just lives off investment income without any worries in the world. So I figure if we're going to reform the tax system to go after consumption, we might as well think about other factors as well to make the system more equitable.

It sounds clean, but that would not be enough to administer a progressive consumption tax of the type that I envision. To have the sort of progressive consumption tax that I envision, you would have to take into account not just income but all wealth or ability to consume of an individual. In our current system, we use income as a poor proxy for ability to consume. Tracking people’s wealth or ability to consume is a lot harder than tracking income. People are able to put their money into all sorts of investment vehicles that grow their ability to consume over time, and this makes it hard for the government to figure out your ability to consume. You would have to require everyone to openly present their personal balance sheet to the government to administer the kind of consumption tax that would be fair. You'd also have to eliminate workarounds that give people the ability to consume without paying the full tax rate on their investments. In your proposal, nothing has changed in the tax code that prevents you from taking out debt that is collateralized by your tax-deferred investments and that is used for personal consumption. To really keep track of consumption, there's a lot more that the government needs to keep track of. In a way, the consumption tax I envision would be a wealth tax. The reality is that these are very difficult policy choices, and neither you nor I know enough or have thought enough about all the ramifications of our policy suggestions. The notion that these are simple questions is laughable.

I read your posts last night, but couldn't summon the effort respond. So here it goes. (Disclaimer: I’m not a tax lawyer. Don’t construe any part of the following post as legal advice. Consult your tax advisor for personal tax matters.) You are conflating dividends with realized individual income. The reason the “dividend tax” goes away when the “investment holding corporation” owns a greater and greater share of the "investee corporation" (a key fact is that the investee is a corporation, since the deduction is only applicable to corporate dividends) is to avoid triple taxation. When the investee corporation is wholly owned by the investment holding corporation, the investee corporation's earnings are taxed at the corporate tax rate of 35%. If the individual controlling the investment holding corporation wishes to use the investee corporation's earnings for personal consumption, he must either dividend the earnings out to himself, incurring double taxation on the resulting individual ordinary income, or sell part of his stake in the investment holding corporation, incurring double taxation on the individual capital gains. As Omagh pointed out, you are deceptively comparing apples and oranges, and as Shalab has pointed out, you can do the exact same thing as Buffett on a smaller scale. You take your realized income, set up a C corporation where you are the controlling shareholder, buy a business, and reinvest all corporate earnings into different businesses. You don't have to be rich to do this. If part of the C corporation earnings come from owning outside passive minority interest (OPMI) stakes in dividend paying corporations, you get to utilize the dividend tax reduction. But you always pay tax at least once on the investment earnings at the 35% rate. If you realize that income, which allows you to use the investee earnings for personal consumption, you pay double taxes. The only way to avoid double taxes is to plow those earnings back into the corporation or extract money by characterizing personal expenses as business expenses, which you are NOT supposed to do. Realization is the key. Buffett’s only advantage is that he has enough money to exert control positions in very large companies and direct when and how those companies' earnings are realized by him. You can do the same thing but only on a smaller scale. To complain that Buffett has so much money that he can buy controlling stakes in large companies is absolutely ridiculous.

You think Buffett is being a hypocrite. Maybe he is. But just because the advocate of a policy position is acting hypocritically does not mean that the policy itself is wrong. Buffett is simply less credible an advocate as a result of his purported hypocrisy. However, I do not think Buffett is being a hypocrite. There's an important distinction between personal dividend income, which is immediately usable for consumption, and wealth locked up as an unrealized investment gain. Buffett cannot personally use all those Wells Fargo dividends that will be coming into Berkshire's coffers to go buy himself a Ferrari. (Yeah, I know he could borrow against his Berkshire shares as a work around, but come on, I doubt he's doing that. And, yes, I get that he could be part of a looting management that uses company accounts as personal piggy banks -- but we all know he doesn't do that.) If he wants to legitimately use that wealth for consumption, he will have to realize capital gains, which he believes is unfairly taxed at a lower rate than income from labor. Only once those gains are taken and taxes have been paid can he then go out and buy his Ferrari. Additionally, I do not think Buffett's motivation for keeping his wealth tied up in Berkshire is to launder his dividends as capital gains. Instead, I think he believes that the world will be better served if the full, untaxed value of those shares is allocated by the Gates Foundation to solve some really difficult problems. First, I have to point out that Berkshire is a legal person, a business entity. It's different than a natural person like you or me. It just so happens that there is one natural person who has a majority of his wealth locked up in shares of that company. And when he decides to utilize that wealth for consumption, he will pay tax on it. Your point about not taking tax out on personal income that is meant for reinvestment is a fair one, and the only reason we don't do that is because it's very difficult to administer a tax regime that only taxes consumption and that is also progressive. There are many tax scholars who would agree that taxing consumption versus investment is the way to go, and the theoretical ideal is to have a cash flow consumption tax be feasible through the use of new technologies. Our current income tax system is a hybrid system that is becoming more like a cash flow consumption tax with all the tweaks and loopholes that have been incorporated into it. Tax-deferred and tax-free retirement accounts are just such a move in that direction. A VAT is an interesting idea, and I could get behind that if it were somehow made progressive, perhaps through a rebate or credit system. I don't really know how other countries use VATs. 1031 exchanges are interesting. I don't know exactly why you can do that with real estate versus financial assets. Perhaps special interests have played a part in putting that provision into the tax code.

I believe what you're talking about was a proposal that would have diverted personal payroll taxes into tax-deferred investment accounts in return for giving up future Social Security benefits. So the average American, who sucks at investing, would be risking future funds guaranteed by American taxpayers for the possibility of earning, at best, a market return minus the transaction costs bleeded out by Wall Street (not to mention the possibility of wipe out during financial crises and times of panic)? I think Buffett was right on that one. What's good for Ericopoly is not necessarily good for the average citizen.

Agreed.

I believe it was Bruce Greenwald and not Joel Greenblatt. Yeah, it was Bruce Greenwald -- the same guy who thinks that Comcast is the investment of the century.

Check out the followng prospectus submitted to the SEC by Fairholme: http://www.sec.gov/Archives/edgar/data/1056831/000091957410007106/d1091470a_40-oip.htm The Existing Fund and Future Funds may offer their shares to VLI and VA Accounts of various insurance companies ("Participating Insurance Companies") to serve as an investment medium to support variable life insurance contracts and variable annuity contracts (together, "Variable Contracts") issued through such accounts. Each VLI Account and VA Account is or will be established as a segregated asset account by a Participating Insurance Company pursuant to the insurance law of the insurance company's state of domicile. Looks like you might be getting your wish, Eric. One caveat. You may have to do business with SunAmerica (AIG) to be able to put your variable annuity into Berkowitz's hands. Bruce B ain't no fool.

I've thought about it, but I'm worried about their competitive positioning in the US. Amazon, Walmart, Target, and other retailers are making life difficult for Best Buy. I recently read that they are considering changing their pricing strategy to become more like Walmart. What will that do to its margins? The Best Buy mobile strategy is interesting, but I have also heard that Apple is considering incorporating a Universal SIM card into its devices so that you go through the Apple website to activate a service plan rather than to a retail store. What happens to their strategy of selling more services per square foot if that gets adopted? It's gonna have to go lower for me to get interested.

Check out the followng prospectus submitted to the SEC by Fairholme: http://www.sec.gov/Archives/edgar/data/1056831/000091957410007106/d1091470a_40-oip.htm The Existing Fund and Future Funds may offer their shares to VLI and VA Accounts of various insurance companies ("Participating Insurance Companies") to serve as an investment medium to support variable life insurance contracts and variable annuity contracts (together, "Variable Contracts") issued through such accounts. Each VLI Account and VA Account is or will be established as a segregated asset account by a Participating Insurance Company pursuant to the insurance law of the insurance company's state of domicile. Looks like you might be getting your wish, Eric.

And as he never points out, why does Berkshire pay less dividend tax than individuals? Better, why does he ask for the individual dividend tax rate to be raised but not the rate that Berkshire pays? I doubt it's because most of his own personal wealth is wrapped up in Berkshire shares. I'm speculating, but I would guess he thinks the corporate tax rate should be lower because any income not distributed to shareholders or employees will be reinvested into the business or into other businesses. It's a question of taxing investment versus consumption (or potential consumption). Additionally, because shareholders of a corporation are often of different backgrounds from a wealth/income perspective, the corporate tax rates are regressive in many ways. For a widely held stock like XOM, for example, pensioners and retirees are having part of their company's earnings taxed at a high tax rate when they pay a lower rates at the individual level. I'm starting to get on board with Bronco and others who want to lower the corporate tax rates and stop penalizing the repatriation of cash, but I also think we need to add several more income tax brackets and jack up the rates on the higher income producers.