How Double Taxed is Warren Buffett ? 35% or 7% ?

Originally Published on forbes.com on August 17th,2011

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Let me start by saying that I believe Mr. Buffett is a stand-up great guy.  He’s very charitable and there is something admirable about him getting out there and saying that he should be paying more than 17.4% on his taxableincome.  The only other number that he gives us in that piece is that the tax was $6,938,744.  Let’s call it $7,000,000 (I’m going to stick with round numbers from here on. So don’t think I’m being sloppy).  From those two numbers we can infer that his taxable income was $40,000,000.

Now from some of the comments I received on aprevious post, Robert Green’s analysis of Mr. Buffett’s return which shows gross income of $62,000,000 is probably not of that much interest.  Because he is so charitable he gets to deduct 30% of his adjusted gross income as a charitable contribution (The limit would be 50% if he were giving cash).  Regardless he is paying about 11.3% of his gross taxable income.  What people tell me is really, really irrelevant is Mr. Buffett’s increase in net worth (presumably from unrealized appreciation).  I had that at $3,000,000,000 but it appears that the latest was $10,000,000,000.  Regardless if you were to consider the net worth increase as economic income then, whether it was 3 or 10, Mr. Buffett’s tax rate on that income measure was 0%, when you round it off.  That is not what I’m here for.

Some people have criticized Mr. Buffett for understating his tax burden  Among them are Joe Kristan and Tim Worstall.  When Mr. Buffett sells corporate stock he is selling, in part, retained earnings that have been already taxed.  Now let’s ignore the argument about  the incidence of the corporate income tax .  Let’s assume for the sake of argument that the burden does fall on the shareholders. They mention the 35% rate.  So does that mean that Mr. Buffett is paying 52.4% ?  Sorry I know this is Forbes I won’t be that silly. The 17.4% is on the net.  That would make for a blended rate of 46.3%.  That is not right either though, of course, and I beg your pardon for even throwing it out there.  I also have to ask you to allow me to make a gross simplifying assumption.  Let’s assume that when Mr. Buffett sells he is selling Berkshire Hathaway.

We can see from its financial statements that in the last three years Berkshire Hathaway had income tax expense ranging from 26% to 30%.  That’s to everybody federal, state and foreign.  On page 53 there is a neat little chart which explains the difference between the actual expense and 35%.  Now those rates are not what Berkshire Hathaway actually paid.  Berkshire Hathaway has over $36,000,000,000 in deferred taxes.  I’m going to have to ignore that piece for now.  Let’s just make a note of that and proceed.  On page 30 we see that Berkshire Hathaway has not quite $100,000,000,000 in retained earnings.  If we go high and assume that was built up at a 30% rate that would be net of  about $43,000,000,000 in income tax expense.  That’s about $26,000 per share or about 24% of the current value of a share of BH trading at $108,580.  Most of that, however has been deferred.  So when Mr. Buffett sells a share of Berkshire Hathaway it has embedded in it taxes actually paid of less than 7%.

Now Joe, who has a great blog that I recommend has already given me an answer to this:

Of course the retained earnings go with the stock. You can’t sell the stock and keep the retained earnings.

Warren also pays an implied tax on the portion of his sales price that represents blue sky, rather than retained earnings. The value of stock is ultimately the present value of the future cash flows — after tax. The future taxes are “paid” on the sale because they lower the expected future cash flows, and thus the stock price.

As I understand the argument Mr. Buffett is implicitly paying a tax because absent the prospect of corporate income taxes his shares would be worth even more than they are.  I need to think about that one.  Let me know what you think.

There may be some flaws in my reasoning or my numbers.  I’m just putting this out there to get the discussion moving.  It is true that Mr. Buffett is probably burdened by corporate tax.  It is a number.  35% is not the number.