Previously we discussed whether or not there was a charity premium–whether money given to charity better invested for societal good than money given to the government. Before I (nervously) get into Part II, I wanted to briefly address some of the comments. I agree with Tom’s suggestion that money taken away from the government wouldn’t result in cuts in the most wasteful government programs but rather some of the least well-funded and socially useful. It’s a sad truth that the worst spending programs–farm subsidies, defense, expensive pensions–are the best represented by lobbyists. It’s unfortunate that the farm bill protects itself by holding school lunches hostage, and odd that it implies we can never get rid of pork barrel projects. The solution is not to starve the government into giving up its pork, but to first get rid of the pork, and put the government on the diet after (of course, it’s hard to starve someone with a triple-A rated credit card). We’re also not suggesting that charity replaces government services, or that government services could ever replace charity. Given the status quo balance between charitable donation and tax revenue, should we tip it a bit to encourage more charitable donation or tip it the other way to increase tax revenue (or keep the status quo)?
I bring all this up because of the recent reports on how Bill Gates and Warren Buffett are lobbying America’s billionaires to donate at least half of their wealth to charity. They would raise $600 billion if America’s portion of Forbes’ 400 richest list sign up. Buffett, of course, has pledged over 99% of his considerable wealth, much of it to a foundation that doesn’t even have his name on it. I think most reasonable people would agree that this type of generosity is pretty noble from all involved.
Buffett made his currently-valued $47 billion fortune as a shrewd investor. He built up his investment machine, Berkshire Hathaway, from the ground up. Yet despite his wealth, he has always lived a relatively frugal life. He famously still lives in the Omaha house he purchased in 1957 for $31,500 ($242,000 in 2010). His biographer implies in The Snowball that Warren’s frugality was due to his drive to always make more money–instead of buying a new suit, Warren thought about how much money he could make if he invested the money instead, in his own company.
Money, of course, doesn’t compound in value solely for great money managers. Entrepreneurs who reinvest in their own business can afford to take less venture capital, increase their personal stake in the company, and amass greater fortunes later on. Taxing individuals at high rates early in their careers reduces their future net worths because it deprives those individuals of needed capital for their businesses. Of course, that’s also money the government uses in funding its programs.
Now if those future billionaires are intending to donate a large amount of their fortunes to charitable causes late in life or upon death, I wonder if it would be more efficient for the government to let the individual donate/”invest” the money for later instead of the government spending it now, as we theorize, inefficiently.
Perhaps there could be a plan where individuals who [contractually?] pledge to donate some very high percentage of their fortunes to pre-vetted charities should be taxed at lower rates until they get there. So for example, instead of taxing Warren Buffett at the highest rate all throughout his millionaire years when he was still building up Berkshire Hathaway, it could have been better to tax him at a lower rate then, wait for him to use that added capital to amass an even larger fortune than he has today, and then have him donate 99% of that even larger fortune.
One problem with this is that the government loses out on individuals who end up losing their wealth, so it’s a gamble that certain people will pay out handsomely in the future. Another criticism is that with the extra capital, people will either be more risky with their investments, or more profligate in their consumption, resulting in a smaller fortune in the end. These could be balanced out by the society/government achieving a much higher sum return (95% to charity might outweigh the yearly 4% additional taxes, particularly after accounting for the charity premium), and the fact that the wealthy will still be motivated by competition to do better, and by inheritance to still maximize the lesser portion of money their descendants get. There’s probably an upper-limit on consumption for most people. A lower and more palatable tax rate might also see less tax evasion and trickery from the wealthy. Finally, there’s an altruism/reputation bonus from charitable donation that the hated estate tax could never replicate.
This idea of course captures the existing anti-tax sentiment that high taxes can lower the productivity of the wealthy (as Alex mentioned, the dead-weight loss of taxation). The difference is that instead of saying the government makes up for the loss in tax revenue only through some overall higher GDP for the country, it also adds a likelihood for society to capture the increased productivity of those particular individuals through promised large charitable contributions later in life.