September 2011

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Shell Game

By Thomas Vincent

Interested readers are invited to check out Tom's Political Blog "Certain Doubt"

In an August 14, 2011 New York Times editorial entitled: “Stop Coddling the Super-Rich,” Warren Buffett called on Congress – pleaded actually – to raise taxes on the mega wealthy:

While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

While on the surface this might seem like an admirable piece of altruism, Buffet’s call for higher taxes on the rich, as noble as it may be, does nothing to address the real problem in our society today: the inequities in our economic system that allow billionaires like Buffett to amass their phenomenal wealth in the first place. Raising taxes on the super rich, though it would help raise revenue and reduce the deficit, does nothing to change the rules of the game that give those same billionaires huge advantages over the average American.

In an August 30th 2011 piece in US News and World Report, Tom Sightings presents as clear a summation as you will find of what I’m talking about. In examining Warren Buffet’s investment in Goldman Sachs for example, Sightings notes:

You, too, could have invested in Goldman Sachs in 2008. But here's the difference between you and Buffett. If you had an extra $12,000, you could have purchased 100 shares of Goldman common stock at $120 a share. Considering that Goldman had been worth over $200 a share the year before, you might have thought you were getting a pretty good discount. You also would be receiving the Goldman dividend of $1.40 a share, a rate of just over 1 percent.

But Buffett had more than $12,000 to invest. He had $5 billion. So he negotiated a much better deal. He bought preferred stock that came with a special dividend. Instead of 1 percent, he negotiated a 10 percent dividend. So now every year he receives a check for $500 million. Then, only after he gets paid, do common stockholders get their paltry 1 percent.

This is the real secret to the success of investors like Warren Buffett. With billions of dollars to throw around, they are able to negotiate sweetheart deals that not only guarantee them a high rate of return, it also guarantees that they will get paid before ordinary folks see a dime in dividends.

It’s almost as though you are playing Monopoly and as soon as one player begins to amass a fortune, the game board begins to actually tilt such that money, houses, and property deeds actually physically slide into their lap.

So now, three years later, how have we done? Goldman is selling at roughly $110 a share, slightly below its 2008 price. If you had invested with Buffett, you would have lost about $1,000. Buffett's lost some capital too, but he's collected $500 million a year in his special dividend.

Raising taxes on the super rich is itself a red herring. The real secret, the real scam behind modern Capitalism, is not whether the tax rate on capital gains is 15% or 20% (or even zero% as one republican presidential candidate has proposed). The real crime is that once you get to a certain level of capital accumulation, you are almost assured of amassing an even more staggering fortune by virtue of the fact that your vast wealth allows you to not only dictate to banks and corporations what your rate of return will be, but also to demand that you will be paid before ordinary shareholders thus reducing your risk to practically nothing.

The rigged nature of the game is even more insidious than it appears. As Sightings shows in his analysis of Buffett’s recent “investment” into Bank of America:

Now Buffett is investing in beleaguered Bank of America. He invested $5 billion in a special preferred stock and will be getting a 6 percent dividend, while the regular stock you can buy pays less than 1 percent. Now I don't know whether Bank of America is a good deal at current prices. Maybe it is. But the point is, if you buy now, you're not getting the same terms as Buffett. You're just pumping money into his dividend payment and hoping for the best.

Think about that the next time you open the financial pages. If you’re fortunate enough to own stock in Bank of America, the fact that Warren Buffett pays a lower tax rate than his secretary should not be nearly as galling as the fact that he gets a 6 times higher rate of return as you do and is guaranteed to receive his money before you see a dime. Still having trouble with this? Consider the numbers in the BOA deal. The math here is not difficult. $5 billion at 6% means Warren is getting $300,000,000. If you invest even $10,000 at 1% you’ll only receive a whopping $100.00! Even after taxes (15%) Warren gets $255,000,000 to your rather pitiful $85 bucks!

This is not to say that Buffet’s plea for higher taxes on the rich is not valid. But where is Buffett’s call for fairness in the game of making money itself? It is certainly not fair that, as he has noted, his secretary pays a higher tax rate - and a higher percentage of her income - than he does. But I don’t hear Buffett – or any other billionaire – complaining about the fact that they are able to command six times the rate of return that ordinary investors receive and even less complaints that they get paid before everyone else.

Thus Warren Buffett, while he may seem altruistic, is really not saying a word about changing the rules of the game which give him an unfair advantage to amass a vast fortune in the first place.