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The Buffett Tax Rate

September 21, 2012 4 comments

Barack Obama has frequently used the tax rate paid by billionaire Warren Buffett to argue for an increase in the personal income tax rates of the rich.  As a matter of fact, it is grossly inaccurate to use Warren Buffet‘s personal income tax rate alone to measure the tax on the incomes of the rich. This is so for the following reasons.

Warren Buffett’s tax rate is that applied to his dividend income, income paid out to him by the firms in which he is a stockholder.  A tax rate of fifteen percent is applied to dividend income by the individual federal income tax.  As pointed out in the Wall Street Journal on more than one occasion, dividend income is taxed at the corporate level before the individual income tax is applied. For this reason, it is frequently said that dividends suffer from double taxation.  Since dividend payments cannot be deducted from the taxable incomes of corporations, they are taxed once at the corporate level and then taxed again on the personal federal income tax returns of the corporation’s stockholders.

Individuals who own stocks are the owners of the firms in which they own shares even though it is left to the firm’s management to decide how much stockholders receive in the form of dividends. Thus stockholders ultimately are paying the corporate income tax on the dividends that they receive at the corporate tax level as well as the tax on dividends they report on their personal tax returns. It would be more accurate to say that the tax rate on dividends may as high as fifty percent depending upon the corporate tax rate paid by a corporation. And all of this ignores any state and local income taxes paid by firms. Including these taxes would only increase the tax rates paid by firms.

Barack Obama has knowingly mislead the public about dividend taxation. It is hard to believe that neither he nor anyone on his staff is unaware of the double taxation of dividends. Thus it is hard to reach any conclusion other than that the President has willfully mislead those members of the public who are unaware of these tax issues. After all, how effective would it be to get people to believe that we should raise the tax rates on the rich by telling the public that the rich are paying as much as a fifty percent tax rate on their dividend income? It is much more effective to say that the rich “only” pay fifteen percent even if that is a gross distortion of the truth. Half-truths and outright distortions unfortunately make up a sizable fraction of what the public hears in election season.

Anna Schwartz, 1915 – 2012

September 10, 2012 Leave a comment

Anna Schwartz was an economist who was not well known to the public. Ironically, Schwartz, who recently died (the New York Times has provided an excellent obituary), was a coauthor of one of the most important scholarly studies ever produced by the economics profession.

Schwartz, along with her coauthor the late Milton Friedman, produced the treatise A Monetary History of the United States. This scholarly work, published in 1963, provided what to this day is the basic framework for our understanding of the banking system and its interaction with central banks. But more importantly, Friedman and Schwartz provided the explanation for the origin of the Great Depression, the single event which gave rise to the discipline of macroeconomics, the area of study within the social science of economics which tries to explain, among other things, the origins of business cycles.

It would be hard to overstate the importance of this research because it provided the explanation of what caused the most traumatic cyclical event in U.S. economic history, a contraction so severe that the U.S. unemployment rate rose to nearly twenty five percent of the work force. Friedman and Schwartz convincingly documented the actions taken by the Federal Reserve which caused a recession to deteriorate into the Great Depression. Their explanation of the cause of the Depression has never been seriously challenged by subsequent economic research and thus remains today as the economics profession’s explanation of the Depression.

More positively, the research of Friedman and Schwartz gives us good reasons to think that the world will never again experience another extreme cyclical contraction. The most recent U.S. recession, beginning in December 2007 and ending in June 2009, could easily have been turned into another Depression if the Federal Reserve had made the same mistakes that it did in the early 1930s. But the proper course of action to be taken by a central bank in recessions is now well understood and the Fed followed the proper course of action to mitigate the recession. While there have been critics of some Fed actions associated with this recession, there is wide agreement among economists that the Fed was right to expand the U.S. money stock in response to the recession which is precisely what the Fed did not do in the early 1930s.

Central banks around the world now know how they should set their policies in recessions and we have Friedman and Schwartz to thank for providing us with this knowledge.

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