Maybe Buffett is just so rich he never says “meh”
November 27, 2012 16 Comments
In this Warren Buffett piece I’m seeing linked approvingly, we once again find our brave hero Warren Buffett making the courageous and selfless argument that millions of nouveau-riche folks who aren’t nearly as wealthy as him – yes, yes, him too, but mostly the nouveau-riche folks beneath him – all need to be taxed more. (To understand the straightforward mathematics that are likely to be motivating this viewpoint, see this post of mine.)
Luckily – because I am too lazy to read it all – the key passage comes at the very beginning:
SUPPOSE that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”
Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 percent.” Only in Grover Norquist’s imagination does such a response exist.
Everyone on the Internet, especially those who have nothing whatsoever to do with finance or investing but like to read and write about rich people and money a lot (such as Slate’s business and economics correspondent Matthew Yglesias) just nodded their heads in agreement. Because Buffett is obviously correct. Investors will behave the same regardless of the capital-gains tax rate.
I’ll just note that Actually, No It’s Not True, at least according to standard correspondence-school/pop-finance theory 101. Has everyone just forgotten? After all:
An investment has a risk. For taking risk, you’re supposed to get a return. The bigger the risk, the bigger the return. And so, whether you decide to invest, depends on whether you think its return outweighs its risk.
So say your friend comes to you with that investment, and after intense study you decide it’s worth the risk – just barely – if the after-tax return is X% or more. Then your friend informs you the after-tax return is indeed exactly X%. Will you buy it? Yes, you will: it meets your bogey. But if taxes are raised, that X% return goes down – and now you won’t buy it, because the risk is the same, but the reward is not, so it’s no longer worth it. So contra Buffett, you will too just leave your cash in your savings account (or seek a different investment anyway, e.g. tax-free munis, if nothing else…), at the relevant margin.
Of course, I’m not saying I buy into this textbook pop-finance 101 risk-reward theory of investing lock stock & barrel. And from his piece, clearly Buffett doesn’t either. But it would be interesting to learn just which part of the above limited application of it he thinks is untrue. Perhaps he thinks people only care about returns in a relative way, i.e. vs other investments, so, as long as the friend’s investment gets the same return as stuff with Similar Risk, it’s all cool. Or perhaps, similarly, he thinks everyone conveniently mentally calculates all their risk-return curves in pretax dollars.
These do salvage Buffett’s assertion (sort of; there is still the issue of munis). But these would be weird, idealized, oversimplified things to think – every bit as much as the ‘risk-return’ theory itself. After all, in the real-world there are fixed costs, frictions, stickiness, and relationships involved with all these decisions. Somewhere, for everyone, there is what I think of as a “Meh” barrier: Would you make a 30-minute phone call to increase your portfolio’s return by 10%? OF COURSE! Would you make that same phone call to increase it by 0.00001%?
Somewhere in between those two investments is a “Meh” barrier, a not-worth-the-brain-damage threshold.
So there is a pretty intuitive and straightforward story one could tell which goes like: As taxes (or for that matter, any other frictions or regulations or paperwork or costs or other barriers) increase, more and more investment options/changes will tend to hit peoples’ “Meh” barriers. And in aggregate that will tend to curb capital investment.
Now, if Buffett doesn’t agree with that – and from the piece one would think that he doesn’t – it would be interesting to learn why. It might in fact be because, as such a large money manager, for all intents he never actually hits those barriers, and indeed he would make a phone call (or rather, press a button) for that extra 0.00001%, because – for him – maybe that’s a lotta money.
But for regular investors? Mostly, it’s not. Ironically, this would mean that all the people pointing at Buffett and saying ‘He’s such a large investor so he knows what he’s talking about’ have it exactly backwards. Maybe he’s such a large investor that he’s simply out of touch with the constraints and frictions that affect most people.