1997: What should the capital gains tax be?

AUDIENCE MEMBER: Good morning, gentlemen. My name is Patrick Byrne. I’m here today from Hanover, New Hampshire.

I’ve searched for a couple questions upon which I might get the two of you to disagree.

First, what level of taxation — and I direct these as much to Mr. Munger, therefore, as to you Mr. Buffett — first, what level of taxation on capital gains is most conducive to the long-term economic health of a society, and is that also the fair or just rate?

In other words, is the just rate of taxation on capital gains precisely that rate that creates the most economic stuff? Or is there some other goal a state might pursue?

And as a not-so-subtly related question, I work in a New Hampshire factory that makes industrial torches.

WARREN BUFFETT: As CEO, I might add, Patrick. (Laughter)

AUDIENCE MEMBER: Say again?

WARREN BUFFETT: As CEO of — that “working” made it sound like you were down there on the floor. I just wanted people to — (Laughter).

Patrick writes me letters from chairman to chairman, so I think we’ve got to get him back at it.

AUDIENCE MEMBER: Continuing. (Laughter)

Well, it’s a small company. I do work as CEO, but it’s not much of a hierarchy.

We make torches used in heavy manufacturing, and the fortunes of our factory echo those of industrial America.

Do you agree with the conventional wisdom that maintains that the age of classical industrial America has passed, and that we will — that America cannot be competitive in the long term with low-wage countries?

So the first question is on taxation of capital gains, and then the second is on the future for industrial America.

WARREN BUFFETT: I have a sensational answer on the tip of my tongue, but I think I’ll let Charlie go first — (laughs) — while I refine it a bit.

CHARLIE MUNGER: Well, I think there’s an easy answer to your capital gain issue. And one is what makes an economy work best in some abstract mathematical sense. And the other is the consideration that you allude to, which gets into issues of fairness.

Aristotle felt that systems work better when they were generally perceived as fair. The civilization worked better if people saw the differences in rewards as having been fairly — reasonably fair, anyway.

And I think that if you had a civilization where if you work 90 hours a week driving a taxicab with no money, no medical insurance and so forth, and somebody else does nothing but own Berkshire Hathaway shares and sit on the country club porch and peel off a few every year to pay the bills, that would be regarded as so unfair that even if it had some theoretical economic efficiency it would be counterproductive for our particular civilization to have that kind of a tax code.

So I’m all for having some taxation of capital gains. Once you reach that conclusion, you get into the question of what should — what is the fair rate?

I think the fair rate might well be a little lower than it is now, but not much lower.

WARREN BUFFETT: Sounds to me like he’s a seller — of Berkshire. (Laughs)

Patrick is a former heavyweight boxer, and just got his Ph.D. fairly recently from Stanford with a 700-page dissertation, which has in it some commentary that actually bears on this.

And I thank Patrick, actually, for introducing me to kind of a system of construct — mental construct — to attack questions like this.

Patrick gave me the example one time — and I think this may go back to John Rawls at Harvard — but he said, just imagine that you were going to be born 24 hours from now.

And you’d been granted this extraordinary power. You were given the right to determine the rules — the economic rules — of the society that you were going to enter. And those rules were going to prevail for your lifetime, and your children’s lifetime, and your grandchildren’s lifetime.

Now, you’ve got this ability in this 24-hour period to make this decision as to the structure, but there — as in most of these genie-type questions there’s one hooker.

You don’t know whether you’re going to be born black or white. You don’t know whether you’re going to be born male or female. You don’t know whether you’re going to be born bright or retarded. You don’t know whether you’re going to be born infirm or able-bodied. You don’t know whether you’re going to be born in the United States or Afghanistan.

In other words, you’re going to participate in 24 hours in what I call the ovarian lottery. (Laughter)

It’s the most important event in which you’ll ever participate. It’s going to determine way more than what school you go to, how hard you work, all kinds of things. You’re going to get one ball drawn out of a barrel that probably contains 5.7 billion balls now, and that’s you.

Now, what kind of a society are you going to construct with that in prospect?

Well, I suspect you would focus on two issues that Patrick mentioned in his question. You would try to figure out a system that is going to produce an abundant amount of goods, and where that abundance is going to increase at a rapid rate during your lifetime, and your children and your grandchildren, so they can live better than you do, in aggregate, and their grandchildren can live better.

So you’d want some system that turned out what people wanted and needed, and you’d want something that turned them out in increasing quantities for as far as the eye can see.

But you would also want a system that, while it did that, treated the people that did not win the ovarian lottery in a way that you would want to be treated if you were in their position. Because a lot of people don’t win the lottery.

I mean, Charlie — when we were born the odds were over 30-to-1 against being born in the United States, you know? Just winning that portion of the lottery, enormous plus. We wouldn’t be worth a damn in Afghanistan.

We’d be giving talks, nobody’d be listening. Terrible. (Laughter)

That’s the worst of all worlds.

So we won it that way. We won it partially in the era in which we were born by being born male, you know —

When I was growing up, you know, women had — they could be teachers or secretaries or nurses, and that was about it. And 50 percent of the talent in the country was excluded from, in very large part, virtually all occupations.

We won it by being white. You know, no tribute to us, it just happened that way.

And we won it in another way by being wired in a certain way, which we had nothing to do with, that happens to enable us to be good at valuing businesses.

And you know, is that the greatest talent in the world? No. It just happens to be something that pays off like crazy in this system. (Laughter)

Now, when you get through with that, you still want to have a system where the people that are born —like Bill Gates or Andy Grove or something — get to turn those talents to work in a way that really maximizes those talents. I mean, it would be a crime to have Bill or Andy or people like that, or Tom Murphy, working in some pedestrian occupation just because you had this great egalitarian instinct.

The trick, it seems to me, is to have some balance that causes the people who have the talents that can produce goods that people want in a market society, to turn them out in great quantity, and to keep wanting to do it all their lives, and at the same time takes the people that lost the lottery and makes sure that just because they, you know, on that one moment in time they got the wrong ticket, don’t live a life that’s dramatically worse than the people that were luckier.

And when I get all through with that long speech, I probably come out with the idea that the capital gains tax as it exists today is probably about right, so —

I see very few people — and I’ve been around a lot of people with money and talent over time — they don’t always go together — but I’ve been around both classes — (laughs) — and the — I see very few of them that are turned off from using their talents by a 28 percent capital gains tax. It just doesn’t happen.

I mean, they do what they like to do. And part of the reason they’re good at what they do is they like to do it. And I’ve just never seen it happen.

And I’ve seen a lot of people that pay taxes that are higher than 28 percent that are contributing more to society, by some judgment other than a pure market system.