Buffett's guilt about paying low taxes may be misplaced

Warren Buffett, the world’s most celebrated investor, feels guilty that he is not paying enough taxes. In an article in The New York Times, he mused aloud about the iniquity of being allowed to get away with paying only 17.4 percent of his taxable income to Uncle Sam, when his non-billionaire colleagues paid more.

His advice to President Obama is to stop coddling the super-rich. While this is a no-brainer in an economic situation in which the government is going bankrupt and the rich hoard their wealth in tax havens, Buffett’s public disclosure of his effective tax rate is essentially his Christian sense of guilt talking. Why am I so rich when so many are poor?

The problem with this kind of self-guilt is that it does no good and flies against good sense. It’s a transparent way of becoming pious, at 81, when you have had your fill of life’s goodies. Having decided to gift most of his billions away to charity, one wonders why Buffett needed to make this strange mea culpa on taxes?

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Buffett’s guilt is seriously misplaced. For four reasons:

One, it is one thing to hoard your wealth purely for personal benefit, quite another to believe that taxes are the right instrument for redistributing the same. If Uncle Sam were spending the taxes he earned efficiently, why would S&P downgrade his credit rating?

Two, the taxes you pay are not limited to personal income tax alone. Buffett may be worrying himself sick over paying just 17.4 percent, but we also pay indirect taxes like excise, value-added tax, and local taxes like octroi, property tax, water tax, motor vehicles tax, et al. The true measure of average taxes paid by us is the tax-GDP ratio, or the percentage of GDP that the government earns in taxes of all kinds from all sources.

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Three, maybe the US citizen does not pay much by way of private forms of taxation - a.k.a. bribes in lay parlance - but in India this is effectively another tax we pay to get things done when they should come free or at low cost.

Four, a rupee in the citizen’s pocket is spent more efficiently than a rupee in the pockets of the government of India. Or Uncle Sam, for that matter. This is one reason why all growth economies tax less (China’s tax-GDP ratio is 17 percent, Malaysia’s 15.5 percent, India’s 16-17 percent, and Singapore’s 14.2 percent).

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High-taxing Europe (almost all countries are 40 percent plus) is digging its own grave with slower growth and higher unemployment. The US is somewhere in between, at around 27 percent - neither too high nor too low. If the ratio had been lower, the US would not be in the mess it is now.

In fact, governments the world over - barring those in very small monocultural societies such as Scandinavia’s - have been very poor at transferring income and wealth from the rich to the poor efficiently. This is why global tax-GDP ratios vary so widely - from almost zero in the Gulf to over 50 percent in northern Europe.

In Scandinavia and northern Europe, citizens tolerate super-high taxes because they are largely monocultural, and hence high-trust societies. In high-trust societies, people do not doubt that taxes are a benefit to themselves and their kin. This is one reason why they oppose high immigration, since it means transfer of resources from “one of us” to “one of them”. It’s not just about xenophobia, but also this economic concern.

In diverse societies like America or India, higher tax rates will always lead to higher evasion for one doesn’t know who the money is going to benefit. This is unstated reason why Tea Party activists want small government - so that their money doesn’t end up with “welfare mothers” or blacks or “people of another kind”.

This is why we, in India, have seen tax evasion levels come down after liberalisation and a reduction of top tax rates. Apart from concerns about who the money is going to, there are also worries about whether the money is at all going to the people it ought to.

In India, the late Rajiv Gandhi estimated that less than 10 percent of anti-poverty schemes reached the poor.

More recently, the World Bank gave a more charitable number: 41 percent. The bank said earlier this year that only 41 percent of the subsidised grain meant for the public distribution system (PDS) actually went to the intended beneficiaries.

Since it is our taxes that enable the subsidisation of the poor, it means Rs 3 out of every Rs 5 we pay as taxes goes waste - at least in this scheme. So it makes little sense to tax me at a personal tax rate of around 34-35 percent when only 14 percent would do in this case.

In fact, the high leakages in the system are one key reason why people prefer to avoid taxes and keep their money to themselves. In low-trust societies like India, compliance depends on high levels of transparency and accountability. If one can be sure where the tax money is going, more people will be willing to bear higher taxes.

It is thus wrong to treat taxes as the sole determinant of what citizens (including the super rich) pay to maintain government services to all and social benefits to the poor. But services to citizens are rendered not only by government, but private citizens too. The rich run charities, and several functions of government - like security - are performed by private parties and non-government organisations, too.

In fact, we now need a new equation to measure the actual level of resources provided by citizens to government and society and it needs to go beyond just taxes.

The real tax rate = Per capita tax-GDP ratio + plus voluntary payments to charity/social causes.

In countries like India, we need to add a third element to this equation.

The real tax rate = Per capita tax-GDP ratio + Plus Charity contributions + Bribes given.

If Anna Hazare’s campaign finally delivers on its promise of reducing bribery, we can either contribute the savings to charity or pay higher taxes.

Meanwhile, Buffett and India’s super rich can feel less guilty about paying less tax. They can do other things with their money to benefit society. A rupee in charity gives bigger bang for the buck than paying it to Uncle Sam as tax.