Doing My Fair Share of Myth Busting

President Obama was at it again today, in a speech in Florida extolling the virtues of the ‘Buffett Rule,’ and equating higher taxes on the rich to being ‘responsible’ and building the American dream for the next generation. Most of the speech was partisan talking points, but I’d like to respond to a couple of the points and examples he made.

Buffett Rule

The impetus for the ‘Buffett Rule,’ a tax of at least 30% effective rate for anyone earning over $1 million annually, is the repeated declaration that Warren Buffett pays a lower effective tax rate than his secretary does. This has been parroted so many times and has received so much recognition, that Buffetts secretary, Debbie Bosanek was invited to sit next to the First Lady at the State of the Union address in January. The charge, led by Buffett himself, is that rich people like him are getting away with murder and that things need to be put right. The truth is that the vast majority of Buffetts income is earned via capital gains, which is taxed at 15%. His secretary is paid a wage, which is taxed at a higher rate. This simple analysis is what is at the backbone of the charges of rich people all over the country getting away with murder. But even a slightly deeper look into the story changes the picture a quite a bit.

As CEO of Berkshire Hathaway, Buffett earns about $100,000 annually. The total income he earned in 2010 was reportedly $62 million, meaning less than 0.2% of his income came from a salary and thus would be taxed at a marginal rate of over 30%. The rest of the income is taxed at the capital gains rate. So immediately, there is hint of hypocrisy in his constant claims for the rich to pay a higher tax rate for the good of the country, when the percentage of his own income that would be affected by such a tax hike is absurdly small.

Corporations are subject to a tax rate of roughly 40%, federal, state and local taxes inclusive. As a quick and simple exercise, take a dollar of corporate earnings and remove the 40% tax rate. This leaves the corporation with about $0.60. Assuming it gives out all of that as a dividend, shareholders in the company will be taxed a further 15% in capital gains, or $0.09. The shareholders are then left with $0.51 after tax. That is a 49% tax rate, which hardly fits the narrative of shirking tax duties or failing to pay a fair share. Of course, the assumption that the corporation would give out all of its after tax earnings as a dividend is far-fetched. The point is that the shareholders, as owners of the corporation are the ones effectively paying the tax on its earnings. Warren Buffett, as the largest shareholder in Berkshire Hathaway sees potential income taxed at the corporate level, as that money could have been paid in dividends. On the personal level, by choosing to pay himself in dividends versus salary, Buffett is making a conscious decision to lower his taxes on money that has already been taxed at the corporate level. It’s at best a disingenuous stance Buffett is taking on this, at worst it’s hypocritical.

Henry Ford

President Obama also invoked the name of Henry Ford, by citing his business practices. He declared:

That’s why a CEO like Henry Ford made a point to pay his workers enough money so they could buy the cars that they were building. Because he understood, look, there’s no point in me having all this and then nobody can buy my cars. I’ve got to pay my workers enough so that they buy and that, in turn, creates more business and more prosperity for everybody.

Of course, he is referring to the famous $5 workday that he instituted in 1914. The reasoning, according to the popular myth, which Obama perpetuated today, is that Ford did this out of some sense of injustice that his workers weren’t being paid and felt the need to spread the wealth. The parallel is made to the economic times of today, in which inequality is rising, leaving Obama pining for CEOs with the integrity and social awareness of Ford, instead of the contemporary versions who are a greedy class getting away with financial murder if the rhetoric is to be believed. The actual reasons behind the institution of the $5 workday were far more pragmatic and less humanitarian – Ford had a problem with absenteeism and quitting. From Ford’s website:

While Henry’s primary objective was to reduce worker attrition—labor turnover from monotonous assembly line work was high—newspapers from all over the world reported the story as an extraordinary gesture of goodwill.

Ford was motivated by reducing the costs of retraining workers, which he had to do repeatedly as turnover was so bad that it took over 52,000 people to do the work of 13,000 jobs in 1913. The costs of constant retraining prompted him to raise wages and shorten the work day from 9 to 8 hours. Workers were rejuvenated, productivity skyrocketed and Ford subsequently took the stage as the leading auto manufacturer. This increased productivity and output led to the reduction of the price of the Model T, from $950 in 1908 to $280 in 1922. That is the reason consumers were able to afford the cars as time went on – due to the decrease in prices owing to an increase in production.

In short, this is an example of free market capitalism at work. Ford, pursuing the interests of his company engaged in a scheme that he would describe as:

One of the finest cost-cutting moves we ever made.

In doing so, he enabled the company to become far more productive, steadily increasing production from 250,000 in 1913 to over 1.8 million by 1922. In the process, the price dropped dramatically, and crucially this enabled the spread of the increased wealth coming from Ford to the masses. And of course Henry Ford himself became fantastically rich in the process. This runs counter to the idea that artificially boosting wages is what leads to the spread of wealth, and more importantly, shows why the fear of falling prices displayed by our policymakers is absurd. Fords prices fell throughout the episode, yet his profits expanded and his personal wealth grew, as did the wealth of the country. Those are the lessons we should be learning from Henry Ford, not the myths President Obama continues to put forth.

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