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Hedge fund manager Cliff Asness, who runs AQR Capital Management, published an op-ed in the Wall Street Journal taking on Warren Buffett’s argument that tax rates don’t really matter.First, here’s the piece from Buffett’s Nov. 25th New York Times‘ op-ed Asness is referring to:
Suppose that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”
Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 per cent.” Only in Grover Norquist’s imagination does such a response exist.
In his WSJ op-ed today called “Warren Buffett Knows That Tax Rates Matter”, Asness says the “Oracle of Omaha” is “patently wrong” here.
The reason, Asness explains in his piece, is that tax rates matter when making investment decisions because the people making those decisions use after-tax cash flows.
Consider how every business-school student, investment banker and investment analyst on Earth has been taught to choose whether to invest in a specific project or company. You make a spreadsheet (a napkin will do sometimes). You put in your best guess of the future cash flows, and you discount those cash flows back to the present at some required rate of return you believe reflects the risk entailed. Of course, opinions about the future cash flows and the proper discount rate can vary widely, but the essential methodology is ubiquitous.
Now here’s the kicker: Nobody who pays taxes and has ever done this exercise has failed (while sober) to use after-tax cash flows in this calculation. Somewhere in the spreadsheet there is a number, say 20%, or 28%, or a Gallic 75%, representing the taxes you’ll pay on the assumed cash flow—and you only count the amount you’ll get after paying this tax. If you turn the tax rate up high enough, projects or companies that looked like good investments become much less attractive and vice versa.
While Asness acknowledges in the piece that Buffett is right in regards to wealthy Americans still investing despite higher tax rates, he believes that there will be fewer and much smaller investments if the after-tax cash flows don’t look so good.
What’s more is Asness explains how those who don’t think taxes matter are being ignorant.
Taxes matter. They matter to business and life decisions alike. They matter to the rich and to the poor. They are, or at least they should be, incorporated into nearly every financial decision made. Discussing tax policy without acknowledging this fundamental reality is bizarre. Actually asserting the opposite is willful ignorance.
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