Warren Buffett Is Wrong!
What he calls "voodoo," is just what we need.


Stephen Moore

Even the great Warren Buffett can be mistaken. In his May 17 article in the Washington Post, “Dividend Voodoo,” Buffett is critical of the president’s proposal to eliminate the double taxation on dividends.

He uses himself as an example of what would happen if the dividend tax exclusion were enacted. This country is fortunate to have a man as rational and successful as Warren Buffett. But he is one of a kind. Any effect legislation has on Buffett is irrelevant. If he doesn’t want the tax cut, which could bring in hundreds of millions of dollars for him, we urge him to return it to the Treasury, or better yet, a conservative charity.

Buffett complains that President Bush’s plan to eliminate the double tax on dividends will not provide the quick economic stimulus needed during a period of higher unemployment and a bearish stock market. We believe the dividend tax cut will jump-start the economy and the stock market almost immediately.

We also believe that there are additional, less-obvious benefits to President Bush’s dividend tax cut that Buffet should appreciate, but ignores.

The plan will change the conduct of business in America, reducing the likelihood of future Enron scandals, and it will significantly benefit charities and educational institutions. For these reasons, this could be the most important tax reform since President Reagan’s reduction of income tax rates in the early 1980s.

Even if the president gets only a 15 percent dividend cut (as now seems the likely outcome), this would make dividend payments more attractive. Companies that have not paid dividends in the past will consider doing so; companies that do pay dividends will be inclined to increase their pay out.

Buffett of all people should know that shareholders think in after-tax terms. That is why they tend to avoid dividend income under the current system, preferring lower-taxed capital gains instead. Naturally, companies respond to these shareholder concerns. Twenty years ago, two-thirds of large companies paid dividends. Today, only about one-fifth do so. For many corporations, repurchasing shares is a more attractive use of corporate cash than paying dividends, especially today with share prices dramatically down. Repurchasing shares can increase the value of each remaining share with no additional shareholder investment or tax liability.

An end to the double tax on dividends will change these incentives. Investors will place a higher value on those companies paying dividends. The value of shares in companies that could pay dividends (but currently do not) will also likely appreciate in anticipation. As share prices rise, repurchasing shares will become less attractive.

Business priorities and practices will also change. Equity will become more attractive relative to debt. The business model characterized by sustainable growth with a prudent proportion of the corporate income stream paid out to investors will become more highly valued. Quarterly results will become less critical in determining share prices. A longer-term focus by both shareholders and management will become incrementally more important. These changes will help restrain irrational bubbles in individual stocks and in the market in general.

Just as lower tax rates led to more charitable giving in the 1980s, excluding dividends from taxation will be a boon to charities. Individual donations are mainly determined by the amount of after-tax cash people receive each year and by how wealthy they feel. The dividend exclusion will produce greater individual after-tax income (as more dividends are paid) and increased wealth (as share prices increase). Thus charitable donations will increase. Since there is far more psychic income from charitable giving during one’s lifetime than at the time of death, charitable bequests could well be converted to annual gifts. Charities and educational institutions will benefit from both increased donations and from increased dividend income on shares of stock they currently hold.

The stock market has suffered an unprecedented decline due to many factors: the greed, malfeasance, and ignorance of some corporate leaders, investment bankers, and venture capitalists; the extraordinary dot-com and telecom bubbles; the terrorist attacks; the war in Iraq; and the SARS epidemic. This is a formidable combination. One could argue that for the economy to perform as well as it has in the face of so many negative forces is clear and powerful evidence of its underlying strength. But why gamble?

What about Buffett’s charge that this is not a real quick stimulus to the economy? Again, he is wrong. By many estimates, stock values could increase in the range of 5 to 15 percent through a dividend and capital-gains tax cut. This is far from trivial. Every percentage point increase in stock values increases Americans’ wealth by roughly $10 billion. This boost in stock prices will engender confidence that could positively impact decisions of corporations to invest. It will also create a significant after-tax bump in investors’ income — funds that can be reinvested, spent, or given away to charities.

Buffett says he would rather have another tax rebate, as was tried in 2001 and by Presidents Ford and Carter in the 1970s. Tax rebates have never worked to stimulate economic growth, because they don’t change fundamental incentives to invest, take risks, and expand businesses. Let us not reinvent failure.

We are pleased that Warren Buffett says the Bush tax cut is “voodoo economics.” That is what critics said of the Reagan tax cut some 20 years ago. But the tax plan of the early 1980s was an unqualified success as a stimulant, turning around a decade of sub-par economic performance. It was a clear signal to investors here and abroad that the high-tax, high-inflation era of the 1970s was ending and that a new, more bullish policy regime was taking hold in America. The Reagan tax cuts energized both consumer and investor confidence. If that is what Buffett means by “voodoo” tax policy, by all means, bring it on.

— Stephen Moore is a senior fellow at the Cato Institute and president of the Club for Growth. Thomas W. Smith is chairman of the board, National Center for Policy Analysis (NCPA), and senior partner, Prescott Investors.


Sign up for free NRO e-mails today:

NRO Polls on LockerDome

Subscribe to National Review