It was quite the week for legendary Berkshire Hathaway CEO Warren Buffett as one of his top lieutenants, and rumored leading succession candidate, unexpectedly resigned amid allegations of insider trading.  Despite Mr. Buffett’s repeated claims of no laws being broken, a matter the SEC will likely weigh in on, many are questioning for the first time Mr. Buffett’s character, reputation and ethics.  As a good example, I would recommend Joe Nocera’s inaugural New York Times column entitled “From Buffett, Excuses, Excuses, Excuses”.  However, this is not the first time that the Oracle of Omaha has seemingly been confused on the facts of a situation when it is convenient for him.

One of the most infamous statements ever made by Warren Buffett is one focused on tax policy.  In an oft-repeated statement, Mr. Buffett has publicly claimed (such as at a $4600-a-seat political fundraiser in 2007) that:

“The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent”.

Later in that same speech, he stated that he was taxed at 17.7% on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at 30 per cent.  Setting aside his obvious attempt to shock as well as the strikingly condescending attitude regarding “our receptionists” and “our cleaning ladies”, let’s examine his claim in further detail.

  • The $60,000 that the secretary earns comes exactly from one source – current wages as a secretary or, as the tax world classifies it, ordinary income.  Thus, those wages are taxed at the marginal tax rate for a $60,000 earner (30% in 2007 according to Warren but 25% under current law…and from I can find, it was 25% in 2007 as well, but we’ll let that one slide).
  • Now let’s look at Warren’s income of $46 million – where does that come from?  Well for years, Mr. Buffett has received a very below-market salary as head of Berkshire Hathaway.  As CEO, he currently receives $100,000.  That $100,000 is taxed at 28% – if that was his only income.
  • So on the apples-to-apples comparison of individual salaries, Mr. Buffett is taxed at a higher rate than his secretary.  In addition, if Warren received a fair salary from Berkshire for his role of CEO – which would likely be MUCH greater than $373,000 (the amount it takes to get you to the top tax bracket currently) – he would be taxed at the 35% rate.
  • Therefore, if Mr. Buffett pays 35% on his $100,000 salary, how can he claim that he only paid 17.7% on $46 million of income?  Simple – he is purposefully mixing his ordinary income (what us normal people would call “salary”) with income from capital gains.  Mr. Buffett is a very asset-rich person – consider his 31% ownership of Berkshire Hathaway valued well north of $40 billion.  He receives a variety of interest payments, dividends and other capital gains on his entire investment portfolio.  These capital gains are either taxed at the short-term capital gain tax rate of 35% (all short-term gains are taxed at the person’s ordinary income rate, which for him, is 35%) or the long-term capital gain tax rate of 15%.

So what does this all mean?  Well if you run simple math at these tax rates, one can easily determine that Mr. Buffett claims to have paid $8.14 million in taxes on his $46 million of “income” or 17.7%.  Assuming his earnings of $100,000 as CEO at Berkshire (taxed at 35% since his other ordinary income would push him to the top bracket), another $6.1 million earned in short-term capital gains and other ordinary income (taxed at 35%) and $39.8 million in long-term capital gains (taxed at 15%), his total tax bill would be $8.14 million or 17.7% of $46.0 million.

So let’s examine Mr. Buffet’s claim that he does not pay enough in income taxes.  And for illustration purposes, let’s jack up his ordinary income rate (and thus also his short-term capital gain rate) to 100%.  That’s right – every dollar earned is immediately paid in taxes!!!  Sounds ridiculous right?!?!?  Well, it is.  But even assuming a 100% tax rate on the income breakdown shown above, do you know what Mr. Buffett’s all-in effective tax rate would be?  26.5%!!!  It would STILL be less than the 30% tax rate that he claims was paid by his secretary in 2007 (and hardly different than the 25% the secretary would pay now)!!!  There is absolutely nothing one can do to the ordinary tax rate to achieve what Mr. Buffett desires! So please Mr. Buffett – argue the facts, not the emotions.  If you want to change the game and pay more in taxes on a percentage basis than your secretary, the debate MUST be focused on long-term capital gains and not ordinary income.  The majority of Americans NEED their salary.  They need it to live on it, pay expenses with it, save some of it, invest in their children’s education and to do a wide variety of other things.  We are NOT asset-rich like you are!  The government can raise the ordinary income rate as much as you want and you’re exactly right – it’s not going to hurt you, Mr.  Buffett! But it’s going to destroy the rest of us that don’t have the stock ownership, assets and the long-term capital gains that you have!! So let me ask you this – are you willing to start paying more taxes on your $39.8 million of long-term capital gains?  How is that going to affect your business and your long-term investment prospects?  Are you willing to make that sacrifice?  If you are ever willing to accurately shift the debate to that topic…just let me know.