On taxing Warren Buffett and Jennifer Anniston?

Warren Buffett is once again pleading for higher taxes on wealthy folks like himself.

Peter Reilly's column in Forbes puts an interesting spin on the topic with his post, We won't get ahead by taxing Warren Buffett more--Jennifer Aniston, Maybe.

The first part of his post does a good job laying out the many complex, conflicting, and emotion-laden issues that arise in discussing tax policy, including many of the issues and arguments that I will address in my upcoming fall term public finance class.

The second part of his post makes the case that taxing Warren Buffett and other extremely wealthy folks more would be a bad idea for society, because he says it is the job of wealthy people to allocate capital, and if we tax them, then they will have less capital to allocate.

He closes by saying how difficult it is to speak out on tax policy issues, because they are so complex and multi-faceted and will inevitably be viewed as wrong-headed by others with a different perspective, but I still applaud the efforts of those like Peter Reilly who do so, because it is a dialog worth having.

Here is my response to his post:

I agree that there are so many issues (most of them laden with emotion) tangled together when one talks about taxation that it is hard to say anything that won't sound foolish when viewed through another lens.

A few observations (through another lens, which will surely strike some as foolish as well):

1) Warren Buffett and other wealthy folks with a reputation for smart investment decisions (whether deserved or not, e.g., Bernard Madoff) allocate more than their own capital.

So the amount of capital that wealthy folks like Warren Buffett have to allocate is not purely a function of their own personal after-tax income, because other entities with funds to invest (e.g., public and private pension funds, insurance companies, college endowments, small investors) are happy to give them their money to invest as well.

2) There is also the question of who judges how well the capital allocators are doing their jobs. Do we think the market and the judgment of investors at large as reflected in market prices is a good metric for that? Classically the answer is yes, but the subprime mess raises questions about the wisdom of markets and whether their judgments are always right. (But then what is the alternative?)

3) It is not always clear that higher taxes discourage work, saving, investment, and risk-taking. In some cases, higher taxes could actually spur people to work more, in order to be able to afford the lifestyle to which they have become accustomed. That is what economists call the "income effect" of a tax. But there is also a substitution effect of a tax, which goes in the opposite direction, because the after-tax payoff for an hour of work has declined while the value of an hour of leisure is not taxed. It is an open empirical question as to which effect predominates in any given situation.

Moreover, there may be other reasons apart from financial rewards why people choose to work, become entrepreneurs, and do other socially productive things. The huge number of volunteers in this country demonstrate that many folks find meaningful work inherently rewarding.

On that point, it is worth noting that Warren Buffett does not allocate all his capital based on the purely financial rewards it earns. He and other wealthy people give a great deal of their capital away to various charitable causes, presumably for benefits that can't be measured in purely dollar terms.

In some cases, taxes do discourage work, saving, investment, and risk-taking. In some cases they apparently do not discourage it. Again, it is an open empirical question, endlessly fascinating to economists, which can only be resolved by looking at the data.

For an example of some interesting data suggesting that higher state taxes does not discourage entrepreneurship, see my recent blog post here. (Interesting coincidental note: the measure of entrepreneurship used in my analysis was developed by economists in Warren Buffett's home state of Nebraska.)

Mary O'Keeffe

Union College

Schenectady NY

Parenthetical addition--another irrelevant but fun coincidence: Warren Buffett spent his teenage years growing up in the same Washington DC neighborhood where I grew up several decades later. His dad was a Congressman, as were some of the dads of my classmates.