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August 18, 2011
All You Can Eat (Warren) Buffet
There is a smorgasbord of economic policy being enacted, defended and recommended lately. But buyer beware, the restaurant has a cockroach problem, a really bad one.
Let's start with the Presidential Press Secretary Jay Carney, who recently extolled the benefits of unemployment payments. "Every place that [unemployment] money is spent has added business and that creates growth," he told a reporter from the Wall Street Journal.
We shouldn't be too hard on Carney; he's just toeing the new party line. In July of 2010, then Speaker of the House Nancy Pelosi said unemployment benefits are the fastest way to create jobs because they "inject demand into the economy." In December 2010 and again earlier this month, the President proclaimed checks to the jobless a key aspect of his job-creation policy.
By this thinking, the only thing between us and full employment is all the people who have jobs.
Unemployment benefits are like a store owner who gives his customers $100 as they walk in the door. The theory is that if the customer then buys products in the store, then the owner is better off. Obviously that's nonsense -- the customer walks out with $100 worth of merchandise and the owner is not compensated. Sure, there is a flurry of activity, cash registers sound, money changes hands, but to what end? Eventually the store runs out of merchandise and has no new money to replace it.
Therein lies the problem with the Administration's veneration of spending. "Spending isn't good," economist Milton Friedman used to say, "what's good is producing." The wealth of the economy is the total goods and services we produce, not what we spend. If the roughly 10% of nation's workforce receives unemployed checks but are not working, the fact that they spend money doesn't change how wealthy we are, because the unemployment checks are written by the other 90%. In other words, the store owners are paying their customers' bill.
As we continue to browse the news, we find Nobel Prize winning economist Paul Krugman. He muses that if the earth were threatened with an alien invasion (I'm not making this up), the world would come together and spend an other-worldly amount of money to stop it. By the time we realized that there were no aliens, we would have already burst out of the economic doldrums.
Krugman's scenario is sort of World War II without the war. However, the Nobel laureate fails to realize or mention that between the Bush Administration stimulus, bank bailout, Obama stimulus and other programs, the federal government has pumped nearly $2 trillion into the economy to combat the recession. On top of that, the Federal Reserve dished out $9 trillion worth of loans during the height of the financial crisis and still held $2 trillion in assets related to the loans late last year. WWII cost a relatively thrifty $3.6 trillion in inflation adjusted dollars.
In truth, war spending didn't rescue the economy in the 1940s. Recovery came after the Roosevelt Administration turned its ire away from American business and toward the Axis Powers. The war put an end to new Depression-prolonging policies and allowed the economy to finally recover.
Finally, the top economic commentary of the week: Warren E. Buffet, one of the world's wealthiest men, wants higher taxes. Buffet writes that he pays a 17.4% tax rate (most of his earnings being taxed at the 15% capital gains rate), but that number starts in the middle of story. A portion of his investment income is paid in dividends -- his share of the profit from the companies in which he own stock. Before he ever sees any money, those profits are subject to corporate taxes. The top business tax rate is 35% and, when combined with the 15% qualified dividend tax rate, makes Buffet's total tax rate for large dividends 50%.
Furthermore, contrary to conventional wisdom, the bulk of hedge fund investments are long-term (one year or more). The long-term value of stock is rooted in the company's profitability. Profit potential (and therefore a company's long-term stock value) is lowered by the corporation's current and future tax bills. Thus corporate taxes are built into long-term investments before Buffet and his peers ever pay their 15% capital gains or qualified dividend tax. Taking the entire story, Wall Street fund managers pay comparable or higher rates to other tax payers.
Buffet goes on to poke fun at the idea that a tax hike would chase away investors. "I should have thrown a fit and refused to invest" when taxes were higher, writes the Berkshire Hathaway CEO, adding, "people invest to make money, and potential taxes have never scared them off." This analysis (which ignores the fact that taxes significantly affect investor behavior) misses the point. Even if the "super-rich" leave their money in the market despite higher taxes, they'll have less capital to invest. With each dollar they pay in taxes, they'll have a dollar less for their next investment.
In other words, we may not lose investors but we will lose investment.
By the time the effects of this reduction in investment ripples through the economy, there will be net loss in tax revenue in the tens of billions of dollars according to a 2009 study.
But more important than the loss in projected revenue is the loss of economic growth, jobs and wealth. As President Obama likes to say, if we raise taxes on the wealthy "they'll still be rich." He is more or less correct, guys like Warren Buffet will still be wealthy, but the rest of us won't be. We won't have the jobs, products, services, loans or investor capital that we need to raise our standard of living and open up opportunities for ourselves and our children.
It's time we leave this buffet table. This food will make us (and the economy) sick.
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