Maboussin on Buybacks vs. Dividends

[ERICOPOLY]

You guys are the ones making this overly complicated. 

 

Look, the whole point of a public company retaining "owner earnings," rather than distributing them, is to reinvest those earnings on behalf of the shareholders, who benefit, get hurt or stay the same from reinvestment on a pro rata basis. 

 

Whether or not we're in a tax free world, if management cannot turn each $1 of retained owner earnings into more than $1, then all owner earnings should be returned to shareholders.  I would go further and argue that unless management can do substantially better than shareholders, as a class, could do by investing that capital on their own, those owner earnings should be distributed to shareholders to do what they wish with it (consume or invest).  Some, like Packer, would institute a bright line rule requiring that 70% of owner earnings must be distributed to shareholders unless shareholders affirmatively agree to allow more reinvestment by management.

 

The economic argument for buybacks versus dividends cannot rest solely on the tax consequences of dividends.

 

In a tax free world, when a company declares a dividend, shareholders actually get capital in their hands which they can use to either consume or invest.  With company-instituted buybacks, on the other hand, the non-selling shareholders have been forced to reinvest in the company by buying out selling shareholders.  The price paid to cash out the selling shareholders will affect whether non-selling shareholders are better or worse off for having distributed company cash to the selling shareholders.  Only in an academic fantasy world, where shares of a firm are always bought and sold at "fair value," are buybacks equivalent to dividends.

 

The only valid reason for company management to institute a buyback is to arrange a cash out transaction between selling and non-selling shareholders that benefits non-selling shareholders in a way that would be superior to using company cash for real investment.

 

I think we have varying degrees of what we consider "academic".  While I consider it entirely practical (and economically rewarding!) to just sell a little bit of stock to offset the buyback, and in doing so come out ahead after taxes, others consider this academic.  Maybe it's because I paid $720,000 about a year ago to the IRS for my 2009 tax bill.  After that experience I will do anything I can come up with (legally) to prevent a recurrence of that.  Once we get past the next couple of years, I fully expect my dividends to push me into a tax rate nearing 40%, despite having 44% of my money in a RothIRA.  Something non-academic needs to happen, and it drives me insane to think this could easily be avoided through the dividend-laundering program known as stock repurchase plans.  Buffett of course has the opposite motivation -- Berkshire is taxed higher on capital gains than on dividends.

 

Out in the real world (not in these academic discussions), these buyback programs on a quarterly basis are typically very small (as percentage of outstanding shares), and bubbles (periods of overvaluation) tend to be relatively brief (only a few years at most except for that 1 in 100 years bubble we just went through). 

 

And of course everyone arguing against me is doing so on the behalf of others -- somewhat like altruistic pro-bono debate mercenaries.  None of you guys would ever be caught dead holding overvalued stock in the first place.

 

 

 

 

 

 

 

[txlaw]

Well, not everyone can manage their money as well as you can in order to avoid the tax hit.  I think we've had this discussion before about your tax arbitrage strategy and how you borrow against part of your securities portfolio in order to avoid taking a tax hit. 

 

Most of us, who won't ever have to worry about paying $700K to the IRS in one year, are better off with cash in hand.  And anyways, there's no guaranty that that tax arbitrage -- realizing value at the capital gains rate rather than at the ordinary income rate -- will be available in a decade or so.  As Buffett always points out, why should income from labor be taxed at higher rates than capital gains?

 

I'll agree with you on this though: I hope to never be caught holding an overvalued stock.

 

I also hope I'm complaining about paying $700K to the IRS in one year at some point.  ;D

[ERICOPOLY]

As Buffett always points out, why should income from labor be taxed at higher rates than capital gains?

 

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?

 

[ERICOPOLY]

Putting it in another way, I would rather have the income to pay the income tax than not have the income. Trying to reduce taxes causes inefficient decision making - IMHO of course.

 

 

I said so many similar things prior to 2006.  Actually, I was sort of still a little bit on board until 2009.

 

Have you guys ever heard of a product called a "variable annuity" -- a few years ago I looked into some offered by Fidelity.  They are basically some weird tax shelter where your money compounds in a bond, equity, or blended mutual fund tax-free just like an IRA.  There is absolutely no contribution limit -- you can put millions into them I figure.  Then the withdrawal rules are similar to regular IRA accounts -- your money is taxed as regular income upon withdrawal.

 

The trouble with such funds for me was the lack of choice -- none were offered with the Fairholme Fund for example.  But this of course got me to thinking... why is it okay to put hundreds of millions of bucks compounding tax-free in a variable annuity, but not if you self-manage the investments in the account?  I mean, these "personal savings accounts" with unlimited contributions were effectively the same thing, but without the huge expenses that these variable annuities charge and Bush's proposal provided the option to self-manage the account.  Do you figure the industry titans that sell these variable annuties and earn these usurious fees lobbied pretty hard to block the self-managed alternative?

[shalab]

>But this of course got me to thinking... why is it okay to put hundreds of millions of bucks compounding tax-free in a variable annuity, but not if you self-manage the investments in the account?  I mean, these "personal savings accounts" with unlimited contributions were effectively the same thing, but without the huge expenses that these variable annuities charge and Bush's proposal provided the option to self-manage the account.  Do you figure the industry titans that sell these variable annuties and earn these usurious fees lobbied pretty hard to block the self-managed alternative?

 

Agree. Sometimes it is surprising how things are rigged against the ordinary citizen by different lobbying groups. Whenever I see this, I go back to Munger - human incentive.

 

 

[txlaw]

As Buffett always points out, why should income from labor be taxed at higher rates than capital gains?

 

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.

[txlaw]

Have you guys ever heard of a product called a "variable annuity" -- a few years ago I looked into some offered by Fidelity.  They are basically some weird tax shelter where your money compounds in a bond, equity, or blended mutual fund tax-free just like an IRA.  There is absolutely no contribution limit -- you can put millions into them I figure.  Then the withdrawal rules are similar to regular IRA accounts -- your money is taxed as regular income upon withdrawal.

 

The trouble with such funds for me was the lack of choice -- none were offered with the Fairholme Fund for example. 

 

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.

 

[Guest Bronco]

Txlaw - the argument of adding brackets is that it adds complexity.  If you still use a Tandy or Commodore 64, there may be some merit.

 

Treating people earning 200k the same as 200m (same bracket) doesn't make sense to me.  You may as well go flat tax.

 

Changing corporate tax policy is a must.  We can't have unfavorable wages AND unfavorable taxes.  Herein lies the exporting of jobs.

 

I am adding nothing new, just retiring some points in my home office.

[txlaw]

Have you guys ever heard of a product called a "variable annuity" -- a few years ago I looked into some offered by Fidelity.  They are basically some weird tax shelter where your money compounds in a bond, equity, or blended mutual fund tax-free just like an IRA.  There is absolutely no contribution limit -- you can put millions into them I figure.  Then the withdrawal rules are similar to regular IRA accounts -- your money is taxed as regular income upon withdrawal.

 

The trouble with such funds for me was the lack of choice -- none were offered with the Fairholme Fund for example. 

 

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.

[ERICOPOLY]

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).

 

I don't think that's it.  He had the opportunity to get behind Bush's "personal savings account", but he spoke out against it rather (as I recall).  

 

The personal savings account would have allowed us to compound our investments tax-deferred and our gains would only be taxed when we withdraw them for consumption.  Basically, similar to IRA accounts but without the restrictions on contributions and withdrawals.

 

He might mean well, and he might not realize he does it, but he effectively says that the rich don't pay enough tax yet he has picked the very vehicle that best shelters himself from these taxes!  Conveniently, he neglects to speak out against what shelters his dividends and instead proposes to raise the tax on mine!  That's why he pisses me off -- there are many reasons why I admire him overall, but on this issue it's rather appalling.

[ERICOPOLY]

As Buffett always points out, why should income from labor be taxed at higher rates than capital gains?

 

I'll tell him why, if he pretends to really not know this.  Go back and look at the history of the S&P500 past 80 years or so.  Dividends paid accounted for most of the real returns, right?  There, that's why.  So called capital "gains" are substantially just nominal gains.  Somewhat like return of "real" capital.  They are not really gains, for the market as a whole.  Now, to prevent people from gaming it (retaining earnings like Berkshire does) they have a capital gains tax that meets you in the middle. 

 

An effort to raise it to income tax rates would need to be justified by some sort of "real" adjustment to the cost basis.  Australia tried that for a while but in the end just figured it's roughly 1/2, so now their cap gains I believe are 1/2 of the income tax rate.

 

 

[rmitz]

Txlaw - the argument of adding brackets is that it adds complexity.  If you still use a Tandy or Commodore 64, there may be some merit.

 

Treating people earning 200k the same as 200m (same bracket) doesn't make sense to me.  You may as well go flat tax.

 

Changing corporate tax policy is a must.  We can't have unfavorable wages AND unfavorable taxes.  Herein lies the exporting of jobs.

 

I am adding nothing new, just retiring some points in my home office.

 

Agreed, there's no reason not to have more brackets.

 

1) We used to have WAAAAY more brackets and people dealt with it just fine.

2) In today's day and age there's no reason just to use a simple graduated mathematical formula rather than brackets.  Make it a continuous function and people aren't going to work so hard to figure out when they should start hiding money and such.

 

I don't think that's it.  He had the opportunity to get behind Bush's "personal savings account", but he spoke out against it rather (as I recall). 

 

The personal savings account would have allowed us to compound our investments tax-deferred and our gains would only be taxed when we withdraw them for consumption.  Basically, similar to IRA accounts but without the restrictions on contributions and withdrawals.

 

Wasn't this specifically about the social security money?  In which case, we've seen how that works out for people--it's a safety net, not a retirement fund.

 

He might mean well, and he might not realize he does it, but he effectively says that the rich don't pay enough tax yet he has picked the very vehicle that best shelters himself from these taxes!  Conveniently, he neglects to speak out against what shelters his dividends and instead proposes to raise the tax on mine!  That's why he pisses me off -- there are many reasons why I admire him overall, but on this issue it's rather appalling.

 

Berkshire pays a ton of taxes, at generally higher tax rates than many other companies.  They don't hide their taxes in offshore subsidiaries (though this is partially because they don't have much overseas, but that's a conscious decision.) If he had continued running hedge funds he'd probably have made far more money, albeit with far more stress.

 

[Guest Bronco]

Although I did hear him say something to the effect of taxing all individuals making over 100m per year at a really high rate.  Not sure what his passive income is, but this may not apply to him either!

 

I'm not sure that I agree that corporations hide their money offshore.  It is my strong belief that the US government, starting with JFK, is responsible for trapping it offshore. 

[finetrader]

It's funny how many people wonder without certainty why Buffett prefers to wholly own the businesses.  I think it's fairly obvious why.

 

Call it agency cost problemless.

 

I, as an investor, find it is one of the biggest risk do deal with.

[ERICOPOLY]

 

Wasn't this specifically about the social security money?  In which case, we've seen how that works out for people--it's a safety net, not a retirement fund.

 

 

It would be interesting to ask him how he'd feel about keeping social security in place but eliminating contribution/withdrawal restrictions for IRA accounts.

 

Were I to place money on his answer, I'd figure he'd say something about how the rich need to pay more taxes, not less.

 

[ERICOPOLY]

Although I did hear him say something to the effect of taxing all individuals making over 100m per year at a really high rate.  Not sure what his passive income is, but this may not apply to him either!

 

That's another example of a tax that would hit the rich but not him.  I am also fairly good at proposing ways to fix the deficit without it meaningfully impacting me -- maybe I should have my shot on CNBC too.  Look, the amount I paid a year ago in taxes for 2009 (as a % of my total net worth) is equivalent to the government confiscating not only all of his non-Berkshire assets, but some of his Berkshire shares as well!  He's not telling the media stories like that!  Instead he gets into these insignificant arguments about how he pays less income tax % than his secretary -- and hiking the income tax would still leave it that way, because most of his income is not paid out by Berkshire!

 

Equity investing is just taxed incorrectly.  Much of our dividends and capital gains are intended for reinvestment -- same as in a corporate holding company like Berkshire.  The simplest fix would be to tear up the tax code completely and just have a national VAT or sales tax -- tax consumption directly.  If txlaw's argument is that Berkshire shouldn't be taxed on what is intended for reinvestment, then the same ought to apply to all of us -- not just those of us rich enough to have a controlling stake in an investment vehicle.  

 

The government already recognizes via the tax code that capital gains on real estate shouldn't be taxed in situations where the capital will be reinvested in more real estate, provided you fill out the right paperwork and reinvest the money within a given window of time.  What in the world is so different about taking a gain on an equity and reinvesting it in another -- why no such equivalent tax deferral?

 

 

[ERICOPOLY]

Right, but I think the point is that the CEO does a good job of capital allocation by buying back undervalued shares from willful sellers when the positive value transfer (not creation) that accrues to remaining shareholders is greater than what they could get by investing themselves on average.

 

I am increasingly thinking that if companies were to just pay out as much as possible and not try to retain earnings for some future "deep discount" buyback then your typical mom and pop investor would earn higher returns.

 

The low or nonexistent level of dividends likely serves to reinforce the myth that these are only pieces of paper that bounce around.  Combined with a market crash, you have the recipe for buy high/sell low.

 

More importantly, when you retire you draw down your 401k.  When it doesn't pay enough income you need to sell some shares.  It's only when you are very wealthy that you can live entirely on dividends.  The more they pay out, the less likely you will be caught selling undervalued shares to fund your living.  So ironically, I think it's the small folk that get hurt the most when companies just sit on the cash rather than pay it out.

 

So cutting the dividend tax to zero would therefore allow companies to boost their payout ratio to the maximum and therefore the little unsophisticated people would do better and benefit by higher investment returns.

 

[ERICOPOLY]

 

Berkshire pays a ton of taxes, at generally higher tax rates than many other companies. 

 

It appears like that on the surface when compared to operating companies.  But really Berkshire is a passive investment operation -- just ask Buffett, he says that he hardly ever interacts with the other managers of the subsidiaries.  Does he therefore make the case that these are merely passive investments:  Sees, GEICO, Burlington Northern???  I mean, if it's passive then why isn't it taxed that way?

 

I believe the way Berkshire gets taxed is the earnings of the wholly owned subs are consolidated and he then pays tax.  Okay, yes in that respect the incremental subsidiary he acquires gets taxed at 35% rate because of the already extreme level of earnings within Berkshire.

 

However, when he takes the post-tax earnings out of Burlington Northern to deploy in a new purchase -- he pays absolutely ZERO on that extraction of profits.  That extraction of profits is a dividend.  But when an ordinary individual takes earnings out of an investment via a dividend, he wants us to get hit at regular income tax rates!  Fine then... let's be fair -- he needs to pay ordinary corporate tax rates when he takes money out of Burlington Northern.  That would put him on an even platform with the rest of us.

 

Look, my soon-to-be 35% tax rate on dividends is a double-tax on the post-tax dividends being paid to me.  That's on top of whatever the company already paid!  Yet Berkshire's maximum tax rate is 35%, and there's no prior round of tax on it.

 

So nice try, Berkshire does not pay that much tax -- at least not compared to the little people who have no such fancy tax shelter.

 

 

 

[txlaw]

Txlaw - the argument of adding brackets is that it adds complexity.  If you still use a Tandy or Commodore 64, there may be some merit.

 

Treating people earning 200k the same as 200m (same bracket) doesn't make sense to me.  You may as well go flat tax.

 

Changing corporate tax policy is a must.  We can't have unfavorable wages AND unfavorable taxes.  Herein lies the exporting of jobs.

 

I am adding nothing new, just retiring some points in my home office.

 

Agreed.

[txlaw]

I don't think that's it.  He had the opportunity to get behind Bush's "personal savings account", but he spoke out against it rather (as I recall).  

 

The personal savings account would have allowed us to compound our investments tax-deferred and our gains would only be taxed when we withdraw them for consumption.  Basically, similar to IRA accounts but without the restrictions on contributions and withdrawals.

 

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. 

 

[txlaw]

He might mean well, and he might not realize he does it, but he effectively says that the rich don't pay enough tax yet he has picked the very vehicle that best shelters himself from these taxes!  Conveniently, he neglects to speak out against what shelters his dividends and instead proposes to raise the tax on mine!  That's why he pisses me off -- there are many reasons why I admire him overall, but on this issue it's rather appalling.

 

That's another example of a tax that would hit the rich but not him.  I am also fairly good at proposing ways to fix the deficit without it meaningfully impacting me -- maybe I should have my shot on CNBC too.  Look, the amount I paid a year ago in taxes for 2009 (as a % of my total net worth) is equivalent to the government confiscating not only all of his non-Berkshire assets, but some of his Berkshire shares as well!  He's not telling the media stories like that!  Instead he gets into these insignificant arguments about how he pays less income tax % than his secretary -- and hiking the income tax would still leave it that way, because most of his income is not paid out by Berkshire!

 

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.

 

Equity investing is just taxed incorrectly.  Much of our dividends and capital gains are intended for reinvestment -- same as in a corporate holding company like Berkshire.  The simplest fix would be to tear up the tax code completely and just have a national VAT or sales tax -- tax consumption directly.  If txlaw's argument is that Berkshire shouldn't be taxed on what is intended for reinvestment, then the same ought to apply to all of us -- not just those of us rich enough to have a controlling stake in an investment vehicle.  

 

The government already recognizes via the tax code that capital gains on real estate shouldn't be taxed in situations where the capital will be reinvested in more real estate, provided you fill out the right paperwork and reinvest the money within a given window of time.  What in the world is so different about taking a gain on an equity and reinvesting it in another -- why no such equivalent tax deferral?

 

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. 

[ERICOPOLY]

I don't think that's it.  He had the opportunity to get behind Bush's "personal savings account", but he spoke out against it rather (as I recall).  

 

The personal savings account would have allowed us to compound our investments tax-deferred and our gains would only be taxed when we withdraw them for consumption.  Basically, similar to IRA accounts but without the restrictions on contributions and withdrawals.

 

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. 

 

Nope.  That's not what I'm thinking of.  I'm thinking of something completely unrelated to Social Security.  I agree with what you say that monkeying around with Social Security to turn it into investment accounts is the wrong approach for the reasons you cited.

 

I swear he proposed this, but perhaps I'm remembering incorrectly, but what I remember is that at some point he proposed a savings vehicle where we could make unlimited contributions at any time, it compounds tax-deferred, and we can withdraw money at any time.  Gains withdrawn would be taxed as income.  So, with no mistake, you only pay taxes when you intend to spend money.  Very simple to administer -- they already have a system for calculating how much of your withdrawal is actually gains versus return of capital... it's called the IRA account.  Very clean.

 

People can't spend their money without paying tax, but only pay tax on what they intend to spend.  The benefit of tax deferral is that taxation doesn't get in the way of trading decisions, so you don't get inefficient allocations of capital merely for tax avoidance reasons.

[ERICOPOLY]

 

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.  

 

Here is something you may not have thought of, or at least, this is what really bothers me the most about Buffett's stance on this matter.  I believe he is going after the merely rich but not the super rich like him -- once you are super-rich like him, your dividend tax rate actually decreases to zero if you play it right.  I'll get to that in the following example:

 

Once you're well into the multiple tens of millions of net worth... perhaps hundreds of millions, (I'm not there yet in either category), you can call up a guy like Harry Long and ask him to locate a company for you that would make a suitable investment vehicle.  He then helps you purchase a controlling stake in such a vehicle.  Now that you are in control, you direct the company to use it's cash flows to accumulate shares of yet another company that you wish to acquire.  Initially, you pay tax on the dividends from these new shares.  But ironically, as your ownership stake rises your dividend tax rate actually DECREASES!  Finally, you've accumulated enough shares and have enough retained cash flow where you just make a final takeover bid for that new company.  You consolidate the newly acquired company and no longer pay any dividend tax whatsoever!!!!

 

So the richer you get, the more of the company you own, the lower your tax rate!

 

And you were saying what exactly about progressive taxation and consumption?  You defended the investment holding company saying that it's easy to differentiate between reinvestment and consumption, but how do you explain the phenomenon that occurs where your dividend tax actually goes to ZERO if you are rich enough to purchase entire companies whole?  Is that pretty much the most regressive tax code in the books?  It has to be!  And Buffett prefers to purchase companies whole, so it isn't like this hasn't occurred to him.  But he doesn't complain too much about it does he?  I've never seen him say anything like "alright, alright, I'll come clean... in all fairness I actually don't pay any dividend taxes at all on BNSF distributions because I'm rich enough to buy the whole thing.".

 

I get what you are saying about his not spending the money from the Wells Fargo dividends -- he can pay a dividend any time he wants however.  It's just that he already has so much money outside of his Berkshire holdings that he'd never need to pay a dividend anyhow.  And that's fine with me... believe me, that's how I think it ought to be for all of us.  

 

And yes, I recognize that Berkshire is a separate legal entity from us individuals.  I just think we should ALSO be allowed a "poor man's" (or not so rich man's) version -- we can design a new legal entity by a new name if that's suitable...  or just go with what i talked about which is to eliminate the restrictions on IRA contributions (or create a similar type of account as this is of a non-retirement nature).

 

But you know, buying holding companies as investment vehicles is kind of expensive in terms of capital, lawyers and complexity.  So my populist suggestion is that if Buffett can have these regressive dividend tax rates in his tax-deferred compounding vehicle, then we all ought to have access to those rates.  Due to our relatively smaller means, the simplest thing is these low-overhead accounts I spoke of that are similar in tax-deferred concept and withdrawal taxes to IRAs.  You could even have capital gains within them taxed if you like to put them on even keel with how Buffett also must pay capital gains taxes in his vehicle.  But just eliminate the dividend taxes in the account as he doesn't have to pay them (due to his ability to acquire whole companies which is a product of his wealth).  And then treat withdrawals from the account the same way dividends are treated from investment holding companies.  Also, allow us to do buybacks from within the account so that we can launder the withdrawals as capital gains (which Buffett is allowed to do even if he neglects to do so).

 

 

 

[rmitz]

Nope.  That's not what I'm thinking of.  I'm thinking of something completely unrelated to Social Security.  I agree with what you say that monkeying around with Social Security to turn it into investment accounts is the wrong approach for the reasons you cited.

 

I swear he proposed this, but perhaps I'm remembering incorrectly, but what I remember is that at some point he proposed a savings vehicle where we could make unlimited contributions at any time, it compounds tax-deferred, and we can withdraw money at any time.  Gains withdrawn would be taxed as income.  So, with no mistake, you only pay taxes when you intend to spend money.  Very simple to administer -- they already have a system for calculating how much of your withdrawal is actually gains versus return of capital... it's called the IRA account.  Very clean.

 

People can't spend their money without paying tax, but only pay tax on what they intend to spend.  The benefit of tax deferral is that taxation doesn't get in the way of trading decisions, so you don't get inefficient allocations of capital merely for tax avoidance reasons.

 

I looked up a bit, and Bush did propose a bunch of new deferred Roth-like accounts to replace the existing retirement accounts structure, but all of them had contribution limits.  I can't find information pertaining to an account with unlimited contribution limits.  That doesn't mean it didn't get discussed, though, seems like it would never make it through congress.

[omagh]

Eric...you're comparing apples and oranges.  The HoldCo (BRK) owns 100% of the OpCo's (BNSF, See's, etc).  They are legally separated for divestment purposes, but effectively, HoldCo and OpCo's are 1 legal entity for taxation.  Transfers of dividends between HoldCo and OpCo are essentially internal transfers of funds post-taxation. If BSNF had been rolled into the BRK entity, you wouldn't even see the funds transfer as dividends, just an internal reshuffling of accounts.

 

In the case where BRK holds a minority position (e.g. WFC, KO, PG, etc), there is a double taxation just as for individuals -- we're now apples to apples.  Buffett made a strategic change several years ago to have more wholly owned subsidiaries to remove the double taxation.  In so doing, it permits capital to flow to the highest returns internally at BRK.

 

Why don't you start a business or three in some underserved markets?  There must be some better societal benefits to your wealth than passive investments that are doubly taxed.

 

-O

 

I believe the way Berkshire gets taxed is the earnings of the wholly owned subs are consolidated and he then pays tax.  Okay, yes in that respect the incremental subsidiary he acquires gets taxed at 35% rate because of the already extreme level of earnings within Berkshire.

 

However, when he takes the post-tax earnings out of Burlington Northern to deploy in a new purchase -- he pays absolutely ZERO on that extraction of profits.  That extraction of profits is a dividend.  But when an ordinary individual takes earnings out of an investment via a dividend, he wants us to get hit at regular income tax rates!  Fine then... let's be fair -- he needs to pay ordinary corporate tax rates when he takes money out of Burlington Northern.  That would put him on an even platform with the rest of us.

 

Look, my soon-to-be 35% tax rate on dividends is a double-tax on the post-tax dividends being paid to me.  That's on top of whatever the company already paid!  Yet Berkshire's maximum tax rate is 35%, and there's no prior round of tax on it.