Kerry's seeking bad advice

Alan Reynolds
Posted: May 06, 2004 12:00 AM

 Sen. John Kerry recruited two famous businessmen to what The New York Times described as his "motley team" of economic advisers. Kerry turned to Steve Jobs of Apple Computer and Warren Buffet of Berkshire Hathaway. (When Kerry said he was fighting for Jobs, we didn't realize he meant Steve).
Buffett is the second wealthiest man in the world. Steve Jobs just received America's second largest executive pay package. Both are amazingly talented at what they do. But what they do not do is economics. Until now, nobody imagined Steve Jobs had any interest in economics. Buffett, on the other hand, has sounded off on numerous topics. Unfortunately, Buffet's paper trail makes it reasonable to conclude that Kerry approves of his views. And that could prove embarrassing.

 One Buffett article the Kerry camp surely enjoyed was opposed to cutting the tax on dividends -- "Dividend Voodoo" in the May 20, 2003, Washington Post. Buffett argued that if Berkshire Hathaway were to pay $1 billion in dividends, then he would receive $310 million in tax-free income under the president's original proposal, and still a good deal even with the final 15 percent tax.

 But Buffet's could easily take out much more than $310 million out of his $43 billion at any time by selling some shares and paying a 20 percent tax (now 15 percent). The capital gains tax was reduced in 1997 and 2003 because people like Buffett who do not have to sell will simply refrain from selling if the tax is too high. Unfortunately, taxing dividends at a higher rate than capital gains encouraged people like Buffett to vote against paying a dividend, even when the alternative was to risk retained earnings on high-yield euro-denominated bonds.

 A major goal of reducing the tax on dividends to 15 percent was to encourage companies like Berkshire to pay a dividend. Berkshire collects dividends from stocks in companies it owns, but still refuses to pay its own shareholders. And Berkshire's 21 percent rise last year did not keep pace with the 29 percent rise in the S&P 500 or the 32 percent average rise among equity mutual funds.

 Buffett's opinions about the desirability of high taxes on dividends happen to be consistent with maximizing his own wealth, but not necessarily with that of his second-class, non-voting shareholders.

 Similarly, Buffett's famous crusade to compel tech companies to expense a bogus estimate of the cost of stock options is consistent with his aversion to owning tech stocks. Expensing would make it much harder for companies like Apple to compete against companies like Coca Cola for executives and capital. Kerry would be wise to keep Buffett and Jobs in separate rooms.

 Buffett's most revealing article appeared in the Nov. 10, 2003, Fortune, titled "America's Growing Trade Deficit Is Selling The Nation Out From Under Us." It began with a "wildly fanciful trip" to two islands, Squanderville and Thriftville, which were both "self-sufficient" until they foolishly started to trade. Then Squanderville began to run trade deficits, which gave Thriftville the Squanderbucks to invest in Squanderville assets. 
 The United States was Thriftville until 1980, says Buffett. "Since then, however, it's been all downhill." But remember what the economy was like in that supposedly wonderful decade before 1980 before you buy into this fable too quickly. And realize that the best long-term example of Thriftville is Japan -- a country that has lost jobs and stock market wealth for a dozen years.

 Buffett is strangely troubled by the fact that the value of foreign-owned assets in the United States exceeds by $2.5 trillion the value of U.S.-owned assets abroad. But whose assets would he rather have -- theirs or ours? He boasts of speculating in foreign currencies, but that isn't investing. Besides, the dollar rose 3 percent last month.

 U.S. assets -- stocks, bonds and real estate -- have risen spectacularly since 1982, the same period when Buffet thinks everything went downhill. Meanwhile, many foreign assets -- such as Japanese stocks and Third World loans -- have fallen in value, some to zero. Some valuable foreign-owned assets include foreign drug companies and auto factories all over the United States. If those U.S. plants employ too many people and become too profitable, then Buffett fears they may end up "paying ever-increasing dividends" to stockholders in companies like Nissan or Bayer. So what? Many Americans own stock in companies like that.

 Clyde Prestowitz once wrote a book called "Trading Places: How We Are Trading Our Future With Japan" (I have seen used copies on Amazon for one cent). Does Buffett really want the United States to trade places with Japan (Thriftville)? If so, why doesn't Berkshire invest in Japanese stocks?

 Buffet shifts from his childish fable to advocating "a tariff called by another name." This draconian scheme is not a tariff, actually, but a very extreme import quota. It would be illegal to ever again import one dollar more than we exported. Buffet views this a "tax on consumers," but more than half of our merchandise imports consist of products essential to U.S. producers -- electronic components for U.S.-made computers and scientific equipment; parts for U.S.-made cars; chemicals for textiles and drugs; basic industrial materials such as oil and metals, and so on.

 If such inputs could be purchased at all under Buffett's plan, their costs would be so much higher than in other countries that the United States could not afford to export anything at world prices. That would require even tighter restrictions on imports. Developing countries hoping to sell to the United States to get the dollars to repay their debts would default and stop trading. With world markets imploding, goods would have to be liquidated far below cost, causing widespread failures of businesses, farms and banks. Buffett does not think his plan should be compared to the Smoot-Hawley tariff of 1930. He's right -- it's worse.

 Buffett's last report to his shareholders cautioned that, "Our country's dynamism and resiliency have repeatedly made fools of naysayers." The trouble with politicians using naysayers like Buffett as economic advisers is that such people cannot resist peddling gloom to voters who can read the headlines and see for themselves that it's utter nonsense. As Arnold Schwarzenegger learned, however, it is not so easy to muzzle an outspoken and charming curmudgeon who's worth billions.

 If Kerry is really looking for sound economic guidance, it would be best to ask a real economist. One of the best, and a self-described Clinton Democrat, is Robert Hall of Stanford. But Kerry might not grasp his enlightened Harvard-bred views on tax policy. Bob Hall, you see, is the co-author of the Hall-Rabushka flat tax.