Paul Krugman: An Unjustified Privilege

Paul Krugman urges Democrats to close the loophole that allows Warren Buffet to be taxed at 17.7 percent while his receptionist is taxed at around 30 percent:

An Unjustified Privilege, by Paul Krugman, Commentary, NY Times: During the 2000 presidential campaign, Ralph Nader mocked politicians of both parties as “Republicrats,” equally subservient to corporations and the wealthy. It was nonsense, of course: the modern G.O.P. is so devoted to the cause of making the rich richer that it makes even the most business-friendly Democrats look like F.D.R.

But right now, as I watch Senate Democrats waffle over what should be a clear issue of justice and sound tax policy..., I’m starting to feel that Mr. Nader wasn’t all wrong.

What’s at stake here is a proposal by House Democrats to tax “carried interest” as regular income. This would close a tax loophole that ... basically lets fund managers take a large part of the fees they earn ... and redefine those fees, for tax purposes, as capital gains.

The effect of this redefinition is that income that should be considered ... ordinary income taxed at a 35 percent rate is treated as capital gains, taxed at only 15 percent instead. So fund managers get to pay a low tax rate that is supposed to provide incentives to risk-taking investors, even though they aren’t investors and they aren’t taking risks.

For example, the typical hedge-fund manager ... gets a fee equal to 2 percent of the funds under management, plus 20 percent of whatever his fund earns. It’s not exactly straight salary, but none of this income comes from putting his own wealth at risk. Except for the fact that he might make a billion dollars a year, he resembles a waitress whose income depends on a mix of wages and tips, or a salesman who lives on a mix of salary and commissions, more than he resembles an entrepreneur who sinks his life savings into a new business. ...

There’s a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I’d say no, because there’s very little evidence that taxing capital gains as ordinary income would actually hurt the economy. ...

But even those who ... think the special treatment of capital gains is justified, should be able to agree that treating the income of fund managers differently from ... everyone else who works for a living makes no sense. And that’s why it’s very disheartening to read that prominent Democratic senators are taking seriously the claims of fund managers that making them pay taxes like regular people would discourage risk-taking.

The immediate response should be: what risk-taking? ...

Look, this isn’t about envy, about punishing success. ... [C]losing the carried interest loophole should be a simple question of fairness: other Americans also earn their pay, but they don’t get special tax breaks. Plus, we’re talking about a lot of lost revenue due to that loophole — revenue that could, for example, be paying for the health care of tens if not hundreds of thousands of children.

And since we’re living in the real world of politics, there’s also the Republicrat issue: the hesitation of the Senate Democrats is terrible for the party’s image. It conveys the impression that they’re as beholden to hedge funds, one of the few types of businesses whose campaign contributions strongly favor Democrats, as Republicans are to the oil and drug industries.

So here’s a plea to Democratic senators on the fence: do the right thing and close this unjustified tax loophole.

_________________________
Previous (7/9) column: Paul Krugman: Health Care Terror
Next (7/16) column: Paul Krugman: The Waiting Game

Comments

[Gabriel M.]

This is not a left-vs-right issue. It's a crappy-fiscal-system issue. Right now, the vast majority of countries have horrible tax codes, from many perspectives, including efficiency and "fairness".

Many flat-taxers are simply loony (and this coming from someone whose country benefited greatly from the flat tax) but they do have a point. K.I.S.S.

[salvatorem]

"The modern G.O.P. is so devoted to the cause of making the rich richer that it makes even the most business-friendly Democrats look like F.D.R."

This quote says it all. The last thing we need are politically slanted macro experts such as Krugman (and lets throw DeLong into this) telling us that we don't have a right to keep our hard earned cash. Today, Krugman picks on fund managers, and after that?

Unfortunately, it IS a left vs. right issue, and will continue to be so, because most politicians seem content to hand out chits to their constituents or are happy managing the welfare class. Where will this newfound tax revenue go?

[Zuil Serip]

First, regarding tax-code complexity and flat taxes: They are not at all the same thing! It is quite possible to have a simple tax system which is not flat and vice-versa. The source of complexity is not looking up the tax-rate for a particular income level, but rather complex definitions of deductions, treatments of different types of incomes, different groups etc, etc, etc.

Second, today's NYT also has an article indicating that by capitalizing on a number of egregious loopholes, in the end the Blackstone group will end up paying much, much less than the 15% Krugman was upset about... http://www.nytimes.com/2007/07/13/business/13tax.html?_r=1&hp=&oref=slogin&pagewanted=print

Maybe this is so transparently over-the-top that this will lead a public outcry and finally lead to congressional action. The cynic in me thinks will see a lot of the former (outcry) and none of the latter (action).

[ECONOMISTA NON GRATA]

Again, it's all about campaign finance reform.... Fairness has many definitions. Eventualy it will all get sorted out one way or another. Let's just hope that it doesn't involve the gallows.

Econolicious

[anne]

http://www.nytimes.com/2007/07/13/business/13tax.html

July 13, 2007

Tax Loopholes Sweeten a Deal for Blackstone
By DAVID CAY JOHNSTON

The Blackstone Group, the big buyout firm, has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public.

Although they will initially pay $553 million in taxes, the partners will get that back, and about $200 million more, from the government over the long term.

The plan, laid out in the fine print of Blackstone’s financial documents, comes as Congress debates how much managers at private equity firms like Blackstone and hedge funds should pay in taxes on their compensation.

Lee Sheppard, a tax lawyer who critiques deals for Tax Notes magazine and has studied the Blackstone arrangement, said it was a reminder of the disconnect between the tax debate in Congress and how the tax system actually operates at the highest levels of the economy.

“These guys have figured out how to turn paying taxes into an annuity,” Ms. Sheppard said. “What people don’t realize is that the private equity managers, the investment bankers, all the financial intermediaries, are in control of their own taxation and so the debate in Washington about what tax rate to pay misses the big picture.”

The debate in Congress is about whether most of the compensation that fund managers earn should be taxed at the 35 percent rate that applies to other highly paid Americans, or at the 15 percent rate for capital gains.

Questions in Congress about possibly raising taxes on such compensation were prompted in part by publicity about the rich rewards for people who run these firms. Stephen A. Schwarzman, the co-founder of the Blackstone Group, made nearly $400 million last year, for example.

The Blackstone partners’ tax deal, however, is for the sale of part of their stake in the management firm, which is why their profits were taxed at the usual 15 percent tax rate for capital gains. Over all, the company raised $4.75 billion in the initial public offering, but the benefits of the tax structure involve just $3.7 billion of that.

Other private equity firms and hedge funds that have gone public, or plan to, make use of similar techniques, their documents show....

[evagrius]

I'm especially interested in the notion of "risk-taking". I suppose that police and fire personnell have a tax break?

[anne]

http://www.nytimes.com/2007/07/13/opinion/13fri2.html

July 13, 2007

The Land of Opportunity?

When questioned about the enormous income inequality in the United States, the cheerleaders of America’s unfettered markets counter that everybody has a shot at becoming rich here. The distribution of income might be skewed, but America’s economic mobility is second to none.

That image is wrong, and these days it abets far too many unfair policies, including cuts in essential programs like Head Start or Medicaid. The poor, we are told, can use their own bootstraps. President Bush got away with huge tax cuts for the rich in part because nonrich Americans, who make up most of the population, believe everybody has a chance of making it into the club. Unfortunately, the American dream is not that broadly accessible.

Recent research surveyed by the Organization for Economic Cooperation and Development, a governmental think tank for the rich nations, found that mobility in the United States is lower than in other industrial countries. One study found that mobility between generations — people doing better or worse than their parents — is weaker in America than in Denmark, Austria, Norway, Finland, Canada, Sweden, Germany, Spain and France. In America, there is more than a 40 percent chance that if a father is in the bottom fifth of the earnings’ distribution, his son will end up there, too. In Denmark, the equivalent odds are under 25 percent, and they are less than 30 percent in Britain.

America’s sluggish mobility is ultimately unsurprising. Wealthy parents not only pass on that wealth in inheritances, they can pay for better education, nutrition and health care for their children. The poor cannot afford this investment in their children’s development — and the government doesn’t provide nearly enough help....

[spencer]

I do not think this loophole actually impacts Buffet.

[bakho]

It is clearly a fairness issue. Another unfair tax break is interest on home mortgages when other interest is not covered. People with a half million in debt get more break than a middle class family with $50,000 mortgage. We could cut rates if we got rid of the special interest exceptions.

[real person from the real world]

Why should someone who doesn't risk anything, but is paid A LOT, pay less taxes then those who are stuck in low paying jobs, or with the uncertainty in income rampant in today's America?
PK: ".... the typical hedge-fund manager ... gets a fee equal to 2 percent of the funds under management, plus 20 percent of whatever his fund earns. It’s not exactly straight salary, but none of this income comes from putting his own wealth at risk. Except for the fact that he might make a billion dollars a year, he resembles a waitress whose income depends on a mix of wages and tips, or a salesman who lives on a mix of salary and commissions, more than he resembles an entrepreneur who sinks his life savings into a new business. ..."

So, if this is supposed to be a pay your own way society.... let these guys actually pay their own way.

[anne]

Spencer

"I do not think this loophole actually impacts Buffet."

That is an important point, Warren Buffett was pointing out what has become a generally regressive tax system for the wealthiest. The tax system is progressive for the middle class and becomes essentially flat for the wealthy while for the wealthiest the tax system has become regressive.

[save_the_rustbelt]

Krugman is right, except this issue has very little to do with Buffet.

Buffet could easily adjust his tax rate by taking a market rate salary and paying dividends.

Buffet doesn't want to pay taxes, so he avoids them.

[jm]

Since there are myriad ways for the wealthy to morph ordinary income into capital gains, it is ridiculous to tax them at different rates.

[anne]

"Buffet doesn't want to pay taxes, so he avoids them."

Rubbish, complete rubbish....

Warren Buffett and all Berkshire Hathaway board executives receive a salary of about $100,000, with no stock option ever. Berkshire Hathaway has never used stock option and never paid a dividend since dividends are to be paid when there is a lack of alternative investments including stock buybacks available. Berkshire have never bought back stock, because there have been superior investment available. Buffett has simply owned shares, the same shares, in Berkshire since the founding.

[anne]

Being more socially conscious, more ethical, more fair in business and more fair to employees than Warren Buffett has been all these years would be difficult indeed. What Buffett and Berkshire Hathaway do is pay taxes that are due.

The point of dividends is always to pay them only when there is no better business investment for the funds. Berkshire is valued in essence on revenue structure and investment potential, which might at some point include a stock buyback or dividend but I would prefer not.

[save_the_rustbelt]

Anne:

You are incredibly gullible re Warren.

He manipulated the system is a way very few public company CEOs do to avoid paying taxes. He intentionally took below market compensation to avoid paying ordinary income taxes and build capital gains.

At any rate, Berkshire-Hathaway is an odd company and thus is an economic outlier at best, so it is not a good model on which to base policy.

Warren beat the system, and now that he is nearing the end he wants to fix the problem.

Get a grip.

[robertdfeinman]

We are seeing a neo-populist theme arise in this country the way it did during the first Gilded Age. If history is any indication there will be some reforms in tax rates, executive compensation schemes and general loopholes. Last time the income tax rate went to 91% during the last act of this little drama.

Unfortunately all of this is a side show. The real issues in the US have to do with the deterioration of self-sufficiency. We no longer create enough educated people to support our requirements. We no longer have enough raw materials to support our needs. We no longer save enough to provide a basis for capital investment. We no longer have government projects to develop and restore needed infrastructure.

Whether Henry Kravitz pays zero taxes or $1 billion will not change any of this. Let's suppose that all the earnings inqualities are fixed and as a result the treasury gets, say, $50 billion a year more in revenue. This is the cost of a month in Iraq.

I've said it before and I'll say it again - the overriding issue is that the US has sacrificed everything to runaway militarism. While we are building bombs, China is building dams and new cities. Which will be more valuable twenty years hence?

Military empires rot from the inside out. First equality is sacrificed, then civil liberties, then the client states slip away and then collapse and civil strife.

[save_the_rustbelt]

Now the crap will hit the fan.............

Tax Loopholes Sweeten a Deal for Blackstone

By DAVID CAY JOHNSTON
Published: July 13, 2007

The Blackstone Group, the big buyout firm, has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public.

Blackstone Makes Good Will Pay

Although they will initially pay $553 million in taxes, the partners will get that back, and about $200 million more, from the government over the long term.

The plan, laid out in the fine print of Blackstone’s financial documents, comes as Congress debates how much managers at private equity firms like Blackstone and hedge funds should pay in taxes on their compensation.

[David H]

Minus the language that is mostly insulting to the Republican party, I agree with Krugman, for once. While disagreeing on the treatment of capital gains, there needs to be greater tax equity in this country to undo the inequity of the Bush cuts and to close the deficit. The tax cuts have accomplished their purpose -- veering the economy away from the downturn that was looming with the crash of the internet and telecom boom and the effects of 9/11.

We need to close the loopholes, shore up the deficit, and have greater tax equity.

[evagrius]

O.K. O.K. The crap dit hit the fan....three times! :)

robertdfeinman;

You're repeating a well known historical truth. Unfortunately, Ibn Kaldhun who was the first to prpose a theory on the rise and fall of empires and their dynasties, is not well known to the ruling elite in the U.S.

If he was, they would recognize themselves in his description of decline. Right now, the U.S. is at perhaps the third/ fourth generation of a dynasty, ( the first generation is quite brilliant with a focus on serving all the people, the second, not so brilliant but dedicated, creating infrastructure and serving the people, the third far less brilliant and dedicated to serving themselves and avoiding service to the people, the fourth definitely stupid and completely selfish having others serve the empire.
For the U.S.,think of the first generation as those who fought in WWII and so on. You'll find the present administration and their ilk in the corporate world as being of the third/ fourth generation.

[anne]

So, we have the crazy meanness of masking the problem of a tax system that is fostering rising income and wealth inequality by blaming, well, Warren Buffett and David Cay Johnston. Poof, no problem.

[anne]

Always crazy meanness. The New Yotk Times editorial is important and excellent as is so strikingly often the case, but we must be sure to show how little we know and understand and appreciate.

[save_the_rustbelt]

So, we have the crazy meanness of masking the problem of a tax system that is fostering rising income and wealth inequality by blaming, well, Warren Buffett and David Cay Johnston. Poof, no problem.

Anne:

If you took the time to read you might be more accurate.

There are significant problems with the tax system.

Warren is a poor spokesman for reform, given his history of highly sophisticated tax avoidance.

On another note:

I wonder how often Warren's long-time mistress is riding on corporate jets, and how often that hits Warren's W-2, as it should.

[paine]

"We no longer save enough to provide a basis for capital investment. "

i get your intent
but this is strictly speaking not true
if you mean productive investment

we generate enough to cover our present investment
in infrastructure
factories ... r and d ...productive skills ...
the usury wing of capital
however
and speculative wing ....

[paine]

rusty
u're so pissed your stream is replicating

[James Killus]

It looks a lot like some person or persons is/are trying deliberately to mangle this discussion. We've got multiple postings, outright identity impersonation, and people slamming Paul Krugman for using Warren Buffet as an example, when it was Mark's intro that mentioned Buffet, not Krugman's column (that last one is only the sort of sloppy drift that usually accompanies these contentious topics, but still).

My question is, why is everyone in such a froth over this? This is a tax loophole that benefits maybe a few thousand people, with the bulk of it going to perhaps a few dozen. Do you think that keeping this loophole is somehow going to may your taxes lower? It has the opposite effect. Do you think it somehow makes your investments more lucrative? Again, probably the opposite is true (this is just more money going to investment fees, which do diddley for investors, but do suck money out of the deals, ultimately to the detriment of investors.

Criminy, I was an advocate of "rational self interest" in my youth, and then I learned how hard it is to find the "rational" part.

[Mark Thoma]

Just to be fair, Krugman mentions the Buffet numbers as well, but I cut that part.

I'm working on cleaning up the rest.

[Jim Ginsburg]

We need to close the loopholes, shore up the deficit, and have greater tax equity.

David H,

How do you reconcile the above with your view that we should not say anything unkind about the Republican Party, since the Republicans have proven that they are for none of the things you propose. Or do you feel that those opposing Republican policies should not speak ill of Republicans because the Republicans are so mild in their rhetoric about the rest of us -- you know: those of us in the reality based community where 2 plus 2 does not equal 5?

[anne]

http://select.nytimes.com/2007/07/13/opinion/13krugman.html

July 13, 2007

An Unjustified Privilege
By PAUL KRUGMAN

There's a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I'd say no, because there's very little evidence that taxing capital gains as ordinary income would actually hurt the economy. Meanwhile, the low tax rate on capital gains is one main reason the truly rich often pay lower tax rates than the middle class.

A couple of weeks ago, Warren Buffett pointed out that he pays an average federal income tax rate of 17.7 percent, while his receptionist pays about 30 percent....

But even those who ...

[The editing is always splendid.]

[David H]

Mr. ginsburg,

Your type of rhetoric and that of Krugman are the type that turn discussions into partisan shouting matches. While not in the majority, there are elements in the Republican Party that believe in those ideals, especially having balanced budgets.

Insults are just not a good way to introduce yourself.

[anne]

"But even those who disagree with me on the larger point, who think the special treatment of capital gains is justified...."

Need to at least think of such a simple problem as setting the tax rate on interest income to the cap[ital gains tax rate as a mild form of equity since interest income is far more important in proportion to moderate income investors. There are, after all, many directions in which to proceed.

[David H]

anne,

You make a good point. Interest income is far more important to middle income folks than capital gains. I might also add that it also applies to senior citizens. Maybe we should toy with idea of taking away the tax-free status of municipals, but that has the drawback of making state and local issued bonds less attractive, and therefore more costly. Much tax revenue though is lost through investments in tax-free obligations. Ted Kennedy would scream bloody murder - hee, hee.

[save_the_rustbelt]

Paine:

The most recent thunderstorms sent my cable intenet provider into the Twilight Zone - humblest apologies for multiple posts.

The issues here are:

a) should capital gains get preferred treatment (I think yes)?

b) if yes, then should Blackstone and their ilk be allowed to manipulate the system in this way (I think no)

c) is Buffet a similar case - not really

d) does Buffet have moral authority to prescribe fixes for the tax system - I think no based on his long history of unusual and aggressive tax avoidance

Here's hoping this posts only once....

[kthomas]

"While not in the majority, there are elements in the Republican Party that believe in those ideals, especially having balanced budgets."

David H.,

Before I or anyone else starts getting too partisan, please name one of these mysterious elements. Just one will do, sir.

Balanced budgets + Republicans....this does not compute..does....not...compute....over load over load.....powering down.

(Mark, sorry if my post causes any drift.)

[anne]

Agreed, older investors would benefit more from a change in tax structure equating interest and capital gains income. But, older investors will in general have more savings. I find no need for older investors to hold much more of a portfolio in bonds though. Actually the market for tax free bonds is overwhelmingly institutional; insurance companies if I remember right.

[worker]

One of the few times I completely agree with Krugman. Carried interest is a joke and taxing it at the (too high) top marginal rate will do nothing to discourage making one way bets with other people's money.

However, Warren Buffett is becoming a real bag of hot air who certainly should know better.

His co's earnings are taxed at the 35% corp rate first and then he is taxed at the mythical 15% on the same earnings when he sells/ dividends. Therefore, "his" earnings as a shareholder are taxed twice with a combined rate of 44.75%, hardly regressive.

[James Killus]

Finding legal methods of paying low taxes does not automatically make Warren Buffet a hypocrite.

If he spent time and money lobbying for tax breaks that would specifically benefit himself, then he would certainly be a hypocrite, as would he be if he chose dodgy methods of tax avoidance like offshore accounts etc., i.e. methods of questionable legality whose main attraction is making tax fraud easier to accomplish.

If anyone knows of cases where Buffet availed himself of such things, I'm all ears. But simply arranging your finances to minimize taxation is assumed behavior, and not doing so in arranging the finances of a public corporation under your control is grounds for a shareholders' suit.

I'll also note that attacking Buffet (and Krugman) personally in these matters reflects the standard strategy of those who wish to avoid actually discussing an issue.

And with the notation that I still maintain my membership in the Republican Party, hoping for the day when some sanity may be applied to its principles and platform, I will reply to David H., who says:

Your type of rhetoric and that of Krugman are the type that turn discussions into partisan shouting matches. While not in the majority, there are elements in the Republican Party that believe in those ideals, especially having balanced budgets.

Personally attacking people by claiming that they engage in personal attacks is exactly the kind of mainstream Republican crap that makes me want to kick someone in the 'nads. If you want to elevate the discussion, then show us how it should be done, and try criticizing some Republican smear tactics once in awhile. Otherwise, tell funnier jokes.

[Cyrille]

Is there any reason for the edition of Krugman's posts? They are short enough to be read in full, aren't they?

[Robert]

A couple of weeks ago, Warren Buffett pointed out that he pays an average federal income tax rate of 17.7 percent, while his receptionist pays about 30 percent
Well, at least his receptionist is remarkably well paid. In order to get to an average federal income tax rate of 30%, the taxable income (at the highest rate: married filing separately) is roughly $267,500.

the overriding issue is that the US has sacrificed everything to runaway militarism
Bingo. Arguing against self interest here, but do we really need an Air Force and Navy more powerful than the rest of the world combined? I don't follow it closely, but sadly, it appears that the military pork disease infects Republicans and Democrats equally.

[Robert]

In terms of interesting potential tax reforms:
- Ease in the elimination of the home mortgage deduction by limiting to some reasonable number and then reducing it over time. Interesting that the AMT seems to accomplish this and that the Dems want to get rid of it.
- Make interest income non taxable for the first $XXXXX amount and increase it over time.
- Ditto for dividends. I think we had something like this once.
IMHO, we need to encourage business to distribute more of their profits as dividends.

[anne]

Generally the last thing that I want from a company is a dividend unless there are no available reasonable alternative investments. Dividends, by the way, for all but the quite wealthy are of little importance with the return being about $17,000 on each million dollars invested. Remember, imputed dividends are fine for increasing stock value.

Still, I do like the idea of a tax exemption on the beginning dollars of interest income.

[anne]

Also, though I have never cared for dividends in making investing decisions, I do not understand the marked decline in dividends from the middle 1980s though I ask about the decline now and then. Taxes were never the issue, and low taxes have not increased dividends.

Warren Buffett and Charles Munger spoke on the use of dividends a few years ago, and confirmed my lack of concern. Still, the general decline was not addressed?

[James Killus]

Well, at least his receptionist is remarkably well paid. In order to get to an average federal income tax rate of 30%, the taxable income (at the highest rate: married filing separately) is roughly $267,500.

It was established at the time that Buffet was probably counting his receptioniist's payroll taxes (which are taxes on income, aren't they?) as well as her "income tax." There is still some question in my mind as to whether Buffet was counting both sides of the payroll tax (employee and employer). The self-employed (which includes "contractors" working side-by-side regular employees in all manner of jobs) pay both sides, with the result that middle income self-employed individuals often see marginal tax rates in excess of 40%.

The refusal to recognize payroll taxes as "taxes" is one of the primary features of the Movement Conservative tax cut shell game.

[David H]

anne,

I don't have any studies to prove my point, but anecdotal. At a previous place of employment, I had the opportunity of viewing the portfolios of trusts of very wealthy individuals, and they seemed to be heavily concentrated in tax-free obligations. In this way, inherited wealth, ala Kennedy, dupont, Rockefeller, pay far less than one would imagine in taxes.

I throw this out to all you economists out there, of which I'm not: Wouldn't it make more sense to tax wealth than income as the primary means of funding government? Taxing income penalizes those, like me, who aspire to attain wealth, who have productive careers that benefit society. Wealth on the other hand only seeks a return, but does not directly add to production. It only provides capital, but is beneficial only if you assume efficient investment and efficient markets.

Wouldn't an overhaul of the tax structure to favor taxation of property, instead of taxation of production be beneficial for the economy, on the theory that high taxation income discourages production? Even taxation of consumption doesn't seem to make as much sense, since it probably slows volatility. Would love to hear thoughts from Mark or any other economists.

[David H]

anne,

Speaking as a layman investor, I think the decline in dividend payouts since the 80s, when I started investing, is probably due to the general decline in interest rates and just plain fashion.

The general decline in interest rates allowed corporations to pay lower dividends in competing with fixed income investments. The fashion element arises in that with two of the best bull markets in history, the 80's and the 90's, corporations found that nobody cared about boring old dividends.

[David H]

For those Buffett detractors, I'd also like to point out that the way he manages to keep his tax bill low, besides the legal ways mentioned above, is that he has remarkably long holding periods for his investments. His holding period is seemingly: forever. So while he's not paying capital gains taxes even, or rarely, he's earning a return on the retained capital consisting of capital gain liability he may not pay for a very long time. Very few investors on this planet have that kind of discipline in holding, or acumen in picking great businesses that maintain their franchise for a very long time.

I've been a great admirer and student of his for years. His methods of tax avoidance are available to anyone and everyone, not just a loophole for the few.

By the way, if anyone didn't know, he's a long time Democrat - pro-abortion rights, etc. See, I said something nice about a Democrat. Does that relieve me of the duty to say something nasty about a Republican other than Bush, who I've trashed many times over elsewhere on this blog?

[Robert]

It was established at the time that Buffet was probably counting his receptionist's payroll taxes (which are taxes on income, aren't they?) as well as her "income tax." I suspected as much, hence my tongue-in-cheek comment. However, including the 15.3% payroll tax moves way beyond looking at the treatment of capital gains, dividends and high payroll income. If the receptionist is in the 15% bracket, then he or she will likely receive a much larger benefit from those payroll taxes than Mr. Buffet. Indeed, the time value of the benefit received will likely far exceed exceed any other potential return on the taxed income. That said, I am perfectly happy turning Social Security into a social welfare program, paying for it out of general revenues and means testing the recipients. Obviously, I am not Movement Conservative. I wonder where the Movement Liberals stand on this issue?

[Worker]

"I do not understand the marked decline in dividends from the middle 1980s though I ask about the decline now and then."

As always, I disagree with Anne and have liked div stocks, but here's an explanation:

Dividends should have disappeared entirely based on the tax code- why pay a dividend taxed at 35% (top marginal rate) when you could buy back stock and allow people to make their own dividend (taxed at cap gains rate of 15%) by selling their stock.

Good public policy would set the div rate at the cap gains rate. The implication of higher div taxes is that every very successful cashflow producing company ultimately goes private (ie. buysback all of their stock until there is 1 share making it private).

That is a f'ed system, which is what we have designed for at least 20 years prior to Bush admin.

Maybe set both at 20%???

[Worker]

Anyone else find it amusing that the Chinese executed the corrupt bureaucrat who looked most like the Evil Chinese Agent in last season's 24. PR for pet food?

Uncanny resemblance.

Actually feel kind of sorry for the guy. Wrong face wrong time.

[James Killus]

I'm not a movement anything, but I would oppose means testing for Social Security recipients. The payback to wealthy individuals appears to be part of the system's underlying support, and the general sense of the "fairness" of it. Weakening this aspect would tend to undermine it and I see no reason for such undermining.

Moreover, for means testing to overcome the additional administrative costs, I suspect that the cutoff point would have to be lowered to the level where it had a noticeable impact of the income of some retirees. Even someone who has a retirement income of $250,000 a year would feel the impact of losing 10% of it.

First things first, and the first things are a return to realistic taxes on inheritances and estates (not the same thing, please note), greater progressivity in the overall tax code, and higher taxes on corporations and capital gains, especially "sterile investments."

Of course that's just the tax part. The destruction of Bush and the kleptocracy should be item number one.

[David H]

worker,

Actually, Under the Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends are taxed at a 15 percent rate for most individual taxpayers. Dividends received by low income individuals are taxed at a five percent rate until December 31, 2007 and become fully untaxed in 2008.

But what you said may have been applicable prior to 2003.

[Jim in Chicago]

David H,

When Krugman and I say "Republican" we are referring to elected officials, not ordinary voters.

And as far as Republican elected officials go, I'm curious: where are the ones who care about such things as balanced budgets and tax fairness and why don't they, you know, actually do something about it? Until they do, I have no problem with Krugman and others calling them on it.

[David H]

Jim in Chicago,

While I've been baited by others on this question, I've kept silent until now. My answering that question in this venue is like a Democrat/Progressive/Liberal answering such a similar question on a neo-con-dominated blog. Imagine being a left-leaner being asked to name a Democrat who's strong on defense. While there are many who spring to the mind of this person, he/she would get trashed mightily by neo-cons who don't think so. It's an exercise in futility to satisfy standards on the extreme edge.

Suffice it to say, there are a number of current Republican presidential candidates that have voted for balanced budget amendments, run governments with fiscal discipline and surpluses, voted against the Bush tax cuts even (but later supported them), have proposed tax reforms that would change our existing tax structure.

Indeed, I'm sure there will be some who will vote for change of or have voiced outrage at the loopholes such as the one afforded hedge funds (which outrage me). I haven't done the research or read enough accounts to pinpoint them.

It's not worth it to name names and have to defend each and every one of them, or else keep silent and appear to not be able to respond. I don't have that kind of time, patience, and inclination. I've given a very direct hint on one name.

I prefer to let the barbs fly as they may without naming names, knowing the deluge that awaits if I open Pandora's box. (The lid moves ever so slightly.)

[Worker]

The 2003 tax cut on divs had a corporate reform purpose also. A tax system that discourages management from paying dividends encourages fake companies like Enron and MCI. Income is an opinion- cashflow is a fact. After the Dot.Com nonsense, dividends contributed to rebuilding some confidence in the markets among investors.

Reading the Wash Post article on Cheney, Bush wanted to keep cap gains at 20% while eliminate the div tax entirely. Cheney basically circumvented him by appealing to the Congressional leadership. Result was 15% on both.

[Lafayette]

PK: There’s a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I’d say no, because there’s very little evidence that taxing capital gains as ordinary income would actually hurt the economy.

Excuse me, but this conclusion seems intuitive. If capital gains on stocks have brought, in the long term, between 10 and 12% per annum returns (when seen over the hundred year period within which they have existed), then why assume that they are a risk and therefore their taxation should be preferential?

What risk? None in the long-term.

Short-term risk, yes. So, tax that heavily such that people invest in the stock market for long-term capital gain - then tax that gain less preferentially. In fact, make it next to nothing if the stock is kept for a reasonably long time frame, say, ten years ... declining gradually each year till the tenth year. Meaning, if you keep your stocks in an Index Fund, which is wise anyway since it spreads the risk, then you pay less tax on it for each year you keep in the fund. It becomes a true pension for old age, run by yourself, so no fees charged.

This will mean hedge-funds will be taxed the most (since they tend to be in and out of the equity market) and poor slobs like me the least (since I have no time for day trading). (Which, of course, is why I am proposing it! 8 ^ )

[anne]

There are hedge funds that trade minimally, and there are fund teams that work almost entirely for short term gains, but the hedge funds I know well are always in the market, always invested rather than timing markets as a whole. Short term trading however is doable but thoroughly difficult, no matter your portfolio size.

[wogie1]

Understandably, there is concern about tax loopholes and the more common preferential treatment of dividends and capital gains. But doesn't the tax code in general provide unequal treatment of income? For example:

A single person with identical taxable income as a married pays more tax

And in arriving at a married person's taxable income the married is allowed exemptions for each parent and child

If a college fund is established taxes are deferred on contributions, and when eventually paid out for education are tax free

I'm not particularly opposed to these tax aspects, but lets recognize the tax system is not equitable in the sense that all income is taxed equally. Why then distinguish only dividends and capital gains?

[David H]

anne,

to expand on what you said, that is why it is difficult to regulate hedge funds -- their functioning and portfolios don't fit nicely into neat categories. There are short term, there are long term. There are ones that invest in stocks, there are ones that only sell short. There are ones that speculate in currencies, ala George Soros, and other commodities and tradable underlyings.

To oversimplify, hedge funds are mutual funds for the rich. Mutual funds can be extremely varied, and hedge funds to an even greater extent.

[David H]

Lafayette,

I'd like to point out that very few of us live 100 years, let alone invest over a 100 year period. My point is that the average return of 10 to 12% is nearly meaningless and is useful as a very general guide only.

There is substantial risk in the equity markets, and if you're close to retirement age, you face risk of never recovering your capital. It took 26 years from 1928 to 1954 (please don't take me to task for these approximations) for the Dow Jones Industrial Average to recover from the 1929 crash. More recently, stocks in the Dow and the S&P have only exceeded their 1999-2000 peaks after about 7 years. If you were heavily laden in tech stocks as most individual investors were, you're still deeply under water, as measured by the Nasdaq 100 which stands currently at 2700, far off its peak of 4700.

[David H]

By the way, my advice to anyone needing to invest in equities is to buy an index fund or an ETF (Exchange Traded Fund) based on an index. I've come to the conclusion that the average person should not be investing in individual stocks (also why Bush's proposal to privatize Social Security while great in theory is dangerous in the real world).

Over the past quarter century, I've made it my hobby, passion, obsession to learn to invest on my own. I've made good money over the past 10 years, but spent the first 15 learning what doesn' work in the stock market. Studying Buffett turned it all around -- and he is far more complex than simple buy and hold. One day, future students of the markets will come to recognize the Buffett-Ben Graham school of investing, once they've dissected and understood Buffett's career.

[Lafayette]

anne: There are hedge funds that trade minimally

The purpose of hedge funds, anne, is to profit from a sector or a market condition. (Which is why they are buying so much market research.) It is certainly not long-term investment, which is the interest of a dedicated investor who is looking to finance their retirement or an eventual house purchase (also a long-term investment).

I contrasted short- and long-term investment horizons to indicate the dichotomy as regards preferential tax treatment. It is bizarre that capital return to people who really don't need it should be given preferential tax rates rather than the bulk of ordinary individuals who are looking to build a retirement nest egg.

Any explanation of why this happens, or just "well, it's always been like that"?

[Lafayette]

dh: There is substantial risk in the equity markets, and if you're close to retirement age, you face risk of never recovering your capital.

Yes, I know all too well. I kept my portfolio unchanged after the dot.com mess and, seven years later, am coming close to recovering its initial value (bought at the end of 1999). I still have faith in the stock market, but no longer any faith in any particular sector. Index Funds spread the risk and that is just fine. I don't need the treble or quadruple of 10/12% per annum to enhance my "feel good factor".

The only sensible thing I did was to sell off entirely my American portfolio (mostly Nasdaq) four years ago and purchase more of the index funds I have in Euros. This is part of the reason I am breaking even. Had I kept the dollar investments, I would still be looking for daylight.

Seven years to recuperate a loss in not long in the career of a person. Nonetheless, I maintain that preferential tax treatment should be given to tenure of the investment and not to its risk. It is far riskier to do short-term investments, and there is no reason, to my mind, why it should receive preferential tax treatment (and thereby benefit the portfolios of those who need no preferential tax treatment whatsoever).

Enough is enough.

[anne]

Part of investing is knowing how to learn, and if you are not a professional or even if your are, generally knowing that you are not as smart as the sort of focused professionals I have known so knowing not to try to compete with them. That leaves knowing how to learn to be simply efficient, and that beyond ego problems is not too hard. Graham can be read with a little difficulty, and Buffett, not about Buffett but Buffett with less difficulty, Swenson is simple and Bogle simplest of all and with ego in control Bogle alone can suffice a lifetime.

But, even being complex remember the rule that professionals are smarter than you are, lots smarter, so learn how to be relatively foolish are effective and efficient as those who are smarter than you are.

[anne]

"learn how to be relatively foolish [but] effective and efficient"

As Buffett and Swensen will explain, no one ever showed more clearly and simply how to be foolish and effective and efficient than John Bogle. The problem investment managers create for themselves or rather for those they manage, repeatedly comes down to as smart as they are they can be wildly expensive putting investors at a disadvantage even when they are winning. But, the expense means the professionals almost always win. How then to win as well is the problem to solve, and the problem can and should be solved.

[Lafayette]

anne: even being complex remember the rule that professionals are smarter than you are, lots smarter

Some may be ... and they make the headlines. They are truly exceptions to the rule. It is naive, however, to think that a method that works for them will work for you. Investments don't work that way. Each investment prospect comports its element of risk that must be taken, and some of us are better assessors than others. (There is no "How to ... " book to learn from.)

Most equity advisory services are typified in the "Vice-President" at a major brokerage that I met. He is salaried but works on a commission. So, he has a "sales target" to meet.

He trundled out most of the banalities that one could hear from a perfectly decent but woefully inadequate asset manager. Such pithy advice as "The stock market is for the long term. So, keep yourself invested regardless of what happens!", coupled with "Technology is the way to go. I'm all for it!" (I can't imagine what he is giving nowadays as "advice" but it is certainly no longer that last bit.)

This is naive beyond any legitimate reason. And yet, this is exactly the sort of "advice" the average Joe is going to get from the average brokerage. Coupled with mailings showing "research" that points in various "investment directions". It's all fluff.

If you do not have a total asset value (excluding real estate) that is not worth at least 1, 2 or 3 million dollars, an investor presently will get nothing of real value or savvy as personal service from these guys.

Brokerage is a business, let's not forget. The commissions on a portfolio of less than a 100K$ are simply not worth five minutes on the phone. Regardless of how much they can churn that account. (Which is why some down-market investment advisory services are being dislocated to India. And, we can imagine the level of service that will get you.)

Which is why Index Funds are getting so much of the action nowadays. It's no miracle, just the way markets work.

A wise distribution of investments is the one that is highly distributed, such as: A third in real estate (your residence), a third at interest and third in index funds. Or, some such - if you can keep the discipline in the face of a stock market when it seems to be printing money. Fool's gold. Like sub-prime mortgages.

At least by distributing the risk from relatively illiquid to liquid investments, one can sleep nights and spend more "quality time" with their children. (Repetitive speculation is only for the most hardy. Better to go to Las Vegas - at least the drinks are free. In either case, the law of numbers will catch up with you.)

[David H]

anne, Lafayette,

As I've learned from this topic, you're both quite knowledgeable. It'd be interesting to know what you do for an occupation.

Lafayette, I agree with you that short term capital gains should not get preferential treatment. My point was to just point out the substantial risk in the equity markets -- especially for the non-savvy, average investor.

I forget who said it, but brokers just make you broker. I know 2 people in my car pool who were hurt by the last internet/tech/telecom boom. One was ripped off by her broker, in my opinion, but shrugs her shoulders when I recommend she sue the SOB; the other is carrying forward tax losses into the foreseeable future. Astoundingly, both are back in the market, and doing well due more to a friendly market than anything else. I counsel where I can, but I can see many people like them being hurt again. The froth, especially in the overseas markets like China, is starting again. Many people lost their entire life savings (including people I know), and it's happening again. As a proponent of free markets, how do we protect these people? Difficult question that I can't think of any answers for. I am glad Bush's proposal to privatize a portion of social security did not pass. Oftentimes, ideology (on both sides) is not grounded in reality.

It takes special qualities to be a successful stock market investors and sometimes it's more of an art than a science. Even very smart people can be unsuccessful. One may be smart but not disciplined. One may be so smart as to be blinded by his/her self-assurance. Unless one is fortunate to find a good advisor or a good approach from the start, successful investing is gaining wisdom from the school of hard knocks. It just blows away ones misconceptions, assuming one is introspective enough to analyze one's mistakes.

[Lafayette]

DH: My point was to just point out the substantial risk in the equity markets -- especially for the non-savvy, average investor.

Mine as well.

It is difficult for ordinary people to understand underlying risks. Whilst those who are supposed "professionals" know well those risks, and yet do not sufficiently warn people away from them, because they have a higher priority -- their commissions/salaries. They put prudence aside and sell risk without a warning sign, harping on the "asset value growth".

The dot.com disaster was a personal catastrophe for many that was just waiting to happen. Market euphoria was literally "printing money" and it was difficult for the more naive to not jump onto the bandwagon, even if it was ultimately going off a cliff.

Still, I maintain, we have something called a "Public Service" the duty of which is to take affirmative control in such situations. If anybody should have been brought to court for neglect of responsibility, it's Alan Greensberg, enshrined in sainthood at the time, for his tepid reaction to the situation -- "exaggerated exuberance" and other such paternal nonsense -- who should have been taken to task. In other words, removed from overseeing a market in which far too many people were investing their lifetime savings, which was quite obviously overheating by leaps and bounds in late 1999. (Hikes in the discount rate would have been salutary, since much of the dynamic was from borrowed money.)

The Fed has a fiduciary, supervisory responsibility/duty as regards financial markets, and the sub-prime fiasco is just another in one too many.

It is obvious that people sometimes need to be protected from themselves, even if adult and even if making decisions in full knowledge of their consequences. They just can't help themselves because they are ... well, naive. Yes, adults can be childlike, when they lose leave of their common sense. (It is a fairly common human phenomenon and happens everywhere.)

The National Health Service would have allowed an epidemic of cholera to have spread across the nation? No. Then why should the Fed not be equally as responsible when markets get out of hand?

Why do humans congregate into communities, the origin of all social and economic activity? Any sociologist will answer immediately: The need for mutual protection, which is primeval.

The notion of the "collective good", or "common welfare" (once upon a time called the "commonwealth"), seems to be one that we've forgot even existed. When that happens, a people, a nation, return to their origins -- survival of the fittest.

And, signs show (at least to me) that such is precisely what is happening.

[Jim in Chicago]

David H,

Voting for a balanced budget amendment to the Constitution and actually doing something meaningful to improve our budgetary situation, such as telling Ted Stevens he can't have his bridge to nowhere or Bush that he can't have his insane tax cuts for the wealthy, are two very different things. Only the second requires any political courage and it is that which I am looking for.

As for McCain (the Senator at whom you hinted), I used to have some respect for him before he sold his soul and drove the "Straight Talk Express" into a ditch.

As for Democrats and national defense, I'd like to see someone tell Jim Webb he's not for a strong defense! Spending money on Star Wars and defense contractor boondoggles (Republicans' specialty) does not make our nation safer (not to mention unnecessary, counter-productive wars while diverting resources AWAY from hunting down those who actually attacked us!). I strongly recommend the documentary "Why We Fight" for a reality check on the military industrial complex and what does and doesn't make us safer.

[David H]

Lafayette,

While I agree with what you wrote in general, I disagree with your assessment of Alan Greenspan. I believe that he was in a very sensitive role as Fed Chairman. I believe I saw enough instances where his remarks were micro-interpreted, probably far beyond his intention. He had the ability, without actually changing the interest rates within his direct control, to move fixed income markets, equity markets, currency markets, etc. Even now, his remarks on the Chinese markets had a delayed effect. His objective in jawboning about "irrational exuberance" was to maneuver the market from overheating. As I recall, the market did respond in kind, but not for the extended period he would have hoped for. However, if he had shouted "fire" I believe he could, and he probably recognized such a possibility, cause a crash himself, and be directly attributed as the villain. In hindsight, an ealier crash might have been preferable, but without the crystal ball to know what did actually happen in the dotcom bubble, he would have been the villain who destroyed the party everyone was enjoying. He might have felt though that he could control the exuberance of the market through occasional jawboning, and thereby maneuver a soft landing.

On your comment that "much of the dynamic was from borrowed money," I'm not sure how much of it was -- certainly far less than the 1920's, when margin requirements were fairly non-existent.

[Lafayette]

JiC: I'd like to see someone tell Jim Webb he's not for a strong defense!

OK, so tell him ... and us. What IS "strong defense".

Defense against what? Against who? Who is actually the menace? Bin Laden in some mountain hole in Waziristan? The Taliban in Afghanistan?

Or, the Russians and their newly found "bull in a China shop" foreign diplomacy?

What new programs are necessary? What new weapons? How many possible wars should be prepared for? 2.5? What kind of war - hi-tech or lo-tech? With what manpower?

Can someone please explain "defense"? And enough of catcalling political enemies as being "soft on defense", this mindless criticism.

Where's the beef?

[Jim in Chicago]

Strong Defense:

I'm no expert, but I'd say it starts with preventing attacks on our homeland, and when we are attacked, going after the attackers in such a way that they and their supporters are never in a position to do it again. This would include transforming "failed states" like Afghanistan that breed terrorism into successful states that don't. If you let places fester, they come back to haunt you. Think of how Germany was left to rot after WWI and what that led to vs. how it was treated after WWII with the Marshall plan and what kind of a country it is today.

Strong defense would definitely NOT include attacking countries that never harmed us or had any capability of doing so and turning them INTO failed states that breed terrorists.

[Lafayette]

JiC: I'd say it starts with preventing attacks on our homeland, and when we are attacked, going after the attackers in such a way that they and their supporters are never in a position to do it again.

Afghanistan attacked no one. Iraq attacked Kuwait and the response (GW1) was approved by the UN. GW2 was approved by Cheney and Wolfowitz.

Also, if we are talking about morality, then let's look in a mirror and asked where the US obtained the right to attack a country (Iraq) that is a member of the UN, when the UN Charter that we signed expressly forbids one member attacking another? Uncle Sam rewrites the rules to his liking?

Since 9/11, Moroccans have killed more than 200 people in Madrid. Did Spain invade Morocco? Five years ago, Algerian terrorist killed 15 people in the Paris underground. Did France invade Algeria? Two weeks ago a gaggle of terrorists from Lebanon, Jordan and Pakistan attacked airports in Britain and the Brits aren't about to invade those countries.

Unilateralism is using a hammer to swat a fly. There is general concensus that the defense against terrorists is to stop them BEFORE they attack. This can mean hunting them down wherever they are and hitting them.

But, it doesn't mean wholesale invasion. That sort of response has to be made through the UN. Unless of course you're a lead-head, gung-ho PotUS.