How Might Berkshire Benefit from the Buffett Rule?

April 30, 2012

I was recently asked how Warren Buffett's company Berkshire Hathaway would benefit from a so-called Buffett Rule that would require the rich to pay at least 30 percent of their income in taxes.

After thinking about it for a while it occurred to me that it is plausible that Buffett's motivation for raising this issue is not about his own embarrassment about his personal taxes, rather it's about the difference in the 35 percent capital gains tax rates paid by publicly traded C-corps like Berkshire and the 15 percent rate paid by its competitors at hedge funds and private equity firms. In short, Buffett is trying to level the playing field between Berkshire and its private competitors.

As I understand it, Berkshire has two main businesses - investing in the stocks of other companies (like a hedge fund) and acquiring other businesses (like a private equity firm). As a publicly traded C-corporation Berkshire pays a 35 percent rate on any capital gains from those transactions while a private equity firm would pay 15 percent on its transaction - either because of the lower individual capital gains rate or through the use of carried interest.

So rather than make the case for a lower capital gains rate for corporations to match the individual rate, Buffett made the opposite case with the story about him paying less than his secretary. This played into the White House's tax the rich strategy and forced a big debate over carried interest and capital gains - from which Mitt Romney has profited.

There is a lot of anecdotal evidence that the 35 percent corporate capital gains rate has a big lock-in effect whereby companies don't get rid of assets as they would like because of the tax hit. Perhaps Berkshire wants to rid itself of some of its acquisitions and doesn't want to take the tax hit.

As long as we're speculating, it's possible too that if a Buffett rule were enacted, some private business owners would decide to sell their business early to beat the rate increase. Berkshire could then buy them at fire sale rates.

Of course, we can't really know the motivations of others, but limiting the tax advantages that private equity firms and hedge funds have is as good as some of the other explanations we've seen lately of Buffett's intentions.

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