ERICOPOLY

I believe what you're talking about was a proposal that would have diverted personal payroll taxes into tax-deferred investment accounts in return for giving up future Social Security benefits. Nope. That's not what I'm thinking of. I'm thinking of something completely unrelated to Social Security. I agree with what you say that monkeying around with Social Security to turn it into investment accounts is the wrong approach for the reasons you cited. I swear he proposed this, but perhaps I'm remembering incorrectly, but what I remember is that at some point he proposed a savings vehicle where we could make unlimited contributions at any time, it compounds tax-deferred, and we can withdraw money at any time. Gains withdrawn would be taxed as income. So, with no mistake, you only pay taxes when you intend to spend money. Very simple to administer -- they already have a system for calculating how much of your withdrawal is actually gains versus return of capital... it's called the IRA account. Very clean. People can't spend their money without paying tax, but only pay tax on what they intend to spend. The benefit of tax deferral is that taxation doesn't get in the way of trading decisions, so you don't get inefficient allocations of capital merely for tax avoidance reasons.

It appears like that on the surface when compared to operating companies. But really Berkshire is a passive investment operation -- just ask Buffett, he says that he hardly ever interacts with the other managers of the subsidiaries. Does he therefore make the case that these are merely passive investments: Sees, GEICO, Burlington Northern??? I mean, if it's passive then why isn't it taxed that way? I believe the way Berkshire gets taxed is the earnings of the wholly owned subs are consolidated and he then pays tax. Okay, yes in that respect the incremental subsidiary he acquires gets taxed at 35% rate because of the already extreme level of earnings within Berkshire. However, when he takes the post-tax earnings out of Burlington Northern to deploy in a new purchase -- he pays absolutely ZERO on that extraction of profits. That extraction of profits is a dividend. But when an ordinary individual takes earnings out of an investment via a dividend, he wants us to get hit at regular income tax rates! Fine then... let's be fair -- he needs to pay ordinary corporate tax rates when he takes money out of Burlington Northern. That would put him on an even platform with the rest of us. Look, my soon-to-be 35% tax rate on dividends is a double-tax on the post-tax dividends being paid to me. That's on top of whatever the company already paid! Yet Berkshire's maximum tax rate is 35%, and there's no prior round of tax on it. So nice try, Berkshire does not pay that much tax -- at least not compared to the little people who have no such fancy tax shelter.

I am increasingly thinking that if companies were to just pay out as much as possible and not try to retain earnings for some future "deep discount" buyback then your typical mom and pop investor would earn higher returns. The low or nonexistent level of dividends likely serves to reinforce the myth that these are only pieces of paper that bounce around. Combined with a market crash, you have the recipe for buy high/sell low. More importantly, when you retire you draw down your 401k. When it doesn't pay enough income you need to sell some shares. It's only when you are very wealthy that you can live entirely on dividends. The more they pay out, the less likely you will be caught selling undervalued shares to fund your living. So ironically, I think it's the small folk that get hurt the most when companies just sit on the cash rather than pay it out. So cutting the dividend tax to zero would therefore allow companies to boost their payout ratio to the maximum and therefore the little unsophisticated people would do better and benefit by higher investment returns.

That's another example of a tax that would hit the rich but not him. I am also fairly good at proposing ways to fix the deficit without it meaningfully impacting me -- maybe I should have my shot on CNBC too. Look, the amount I paid a year ago in taxes for 2009 (as a % of my total net worth) is equivalent to the government confiscating not only all of his non-Berkshire assets, but some of his Berkshire shares as well! He's not telling the media stories like that! Instead he gets into these insignificant arguments about how he pays less income tax % than his secretary -- and hiking the income tax would still leave it that way, because most of his income is not paid out by Berkshire! Equity investing is just taxed incorrectly. Much of our dividends and capital gains are intended for reinvestment -- same as in a corporate holding company like Berkshire. The simplest fix would be to tear up the tax code completely and just have a national VAT or sales tax -- tax consumption directly. If txlaw's argument is that Berkshire shouldn't be taxed on what is intended for reinvestment, then the same ought to apply to all of us -- not just those of us rich enough to have a controlling stake in an investment vehicle. The government already recognizes via the tax code that capital gains on real estate shouldn't be taxed in situations where the capital will be reinvested in more real estate, provided you fill out the right paperwork and reinvest the money within a given window of time. What in the world is so different about taking a gain on an equity and reinvesting it in another -- why no such equivalent tax deferral?

It would be interesting to ask him how he'd feel about keeping social security in place but eliminating contribution/withdrawal restrictions for IRA accounts. Were I to place money on his answer, I'd figure he'd say something about how the rich need to pay more taxes, not less.

I'll tell him why, if he pretends to really not know this. Go back and look at the history of the S&P500 past 80 years or so. Dividends paid accounted for most of the real returns, right? There, that's why. So called capital "gains" are substantially just nominal gains. Somewhat like return of "real" capital. They are not really gains, for the market as a whole. Now, to prevent people from gaming it (retaining earnings like Berkshire does) they have a capital gains tax that meets you in the middle. An effort to raise it to income tax rates would need to be justified by some sort of "real" adjustment to the cost basis. Australia tried that for a while but in the end just figured it's roughly 1/2, so now their cap gains I believe are 1/2 of the income tax rate.

I don't think that's it. He had the opportunity to get behind Bush's "personal savings account", but he spoke out against it rather (as I recall). The personal savings account would have allowed us to compound our investments tax-deferred and our gains would only be taxed when we withdraw them for consumption. Basically, similar to IRA accounts but without the restrictions on contributions and withdrawals. He might mean well, and he might not realize he does it, but he effectively says that the rich don't pay enough tax yet he has picked the very vehicle that best shelters himself from these taxes! Conveniently, he neglects to speak out against what shelters his dividends and instead proposes to raise the tax on mine! That's why he pisses me off -- there are many reasons why I admire him overall, but on this issue it's rather appalling.

I said so many similar things prior to 2006. Actually, I was sort of still a little bit on board until 2009. Have you guys ever heard of a product called a "variable annuity" -- a few years ago I looked into some offered by Fidelity. They are basically some weird tax shelter where your money compounds in a bond, equity, or blended mutual fund tax-free just like an IRA. There is absolutely no contribution limit -- you can put millions into them I figure. Then the withdrawal rules are similar to regular IRA accounts -- your money is taxed as regular income upon withdrawal. The trouble with such funds for me was the lack of choice -- none were offered with the Fairholme Fund for example. But this of course got me to thinking... why is it okay to put hundreds of millions of bucks compounding tax-free in a variable annuity, but not if you self-manage the investments in the account? I mean, these "personal savings accounts" with unlimited contributions were effectively the same thing, but without the huge expenses that these variable annuities charge and Bush's proposal provided the option to self-manage the account. Do you figure the industry titans that sell these variable annuties and earn these usurious fees lobbied pretty hard to block the self-managed alternative?

And as he never points out, why does Berkshire pay less dividend tax than individuals? Better, why does he ask for the individual dividend tax rate to be raised but not the rate that Berkshire pays?

I think we have varying degrees of what we consider "academic". While I consider it entirely practical (and economically rewarding!) to just sell a little bit of stock to offset the buyback, and in doing so come out ahead after taxes, others consider this academic. Maybe it's because I paid $720,000 about a year ago to the IRS for my 2009 tax bill. After that experience I will do anything I can come up with (legally) to prevent a recurrence of that. Once we get past the next couple of years, I fully expect my dividends to push me into a tax rate nearing 40%, despite having 44% of my money in a RothIRA. Something non-academic needs to happen, and it drives me insane to think this could easily be avoided through the dividend-laundering program known as stock repurchase plans. Buffett of course has the opposite motivation -- Berkshire is taxed higher on capital gains than on dividends. Out in the real world (not in these academic discussions), these buyback programs on a quarterly basis are typically very small (as percentage of outstanding shares), and bubbles (periods of overvaluation) tend to be relatively brief (only a few years at most except for that 1 in 100 years bubble we just went through). And of course everyone arguing against me is doing so on the behalf of others -- somewhat like altruistic pro-bono debate mercenaries. None of you guys would ever be caught dead holding overvalued stock in the first place.

Good post. I've been thinking more and more about my own retirement recently (though i am in my 30s), and would be perfectly happy living a modest life free of work. I thought i would share my family's experience to show the money one might need to retire comfortably (which of course is relative). My father (who passed away about 12 years ago) retired at 39. He was an mechanical engineer (and a stockbroker in his younger years). He passed away at 72 years of age. So he lived nearly half his life in retirement and traveled religiously for vacations during retirement to remote cheap locations like Central America for many months at a time. (Great memories). My mother has never worked since she married my father many years ago. --With the background out of the way... I manage her retirement money for her now and she is now 63 and perfectly healthy. She has raised 4 kids and put them all through college and graduate/law school (not leaving any of us with any student debt upon graduating), in what i would consider a very comfortable upbringing. She has a net worth of approximately $1.4 million now in investments (currently about 50% in mostly dividend paying equities and the rest in fixed income & cash) and a home worth about $300,000 which is a great modern 4 bedroom home (in the South that amount can buy a great home). So her net worth is $1.7 million including residence. She has no mortgage, and no debt. She takes about 4 vacations per year usually lasting about a week (or three) each time, and lives an extremely comfortable life without any need to worry about having enough money. Soon she'll be receiving social security that would add about $20,000/year to her annual income, which she really doesn't need, because that 1.4 million is more than enough to live her comfortable life in retirement, doing all the things she wants to do. How did you view work after a childhood of not witnessing your father going to work? I only ask that because I left the workforce two months before my son was born and my daughter was two at the time. They are now nearly 3 and 5. Some in the family have a theory that somehow they will be damaged by not seeing me routinely "go to work", but as for now I believe they benefit from having two parents with time to spend with them.

Got it, you were quoting Rosenberg. I guess I don't understand why he brings up the prices of bonds, asking what it tells us. One might have said in 2006 that the price of bonds told us that collapse in demand was not coming, and then one could say today that the price of bonds suggests no coming growth in demand. Why would we bolster an argument today using bond prices after learning how poorly the current predicament was forecast by bond prices before the collapse happened? If bond prices are set by the crowd, then why is the respected economist asking the crowd what to think? The crowd is probably also following what Rosenberg is saying, given that he is one of the thought leaders. So it's sort of a circular reference in a way between Rosenberg and the crowd. I just don't get it -- it sort of completely ignores the pithy wisdom about how the market is there to serve, not to instruct. You are correct in how you described what the earnings of the S&P500 are telling us. However when I asked the question I meant to refer to the PRICE, but I wasn't explicit. The price of course is a factor of future expectations, not just current. It was brought up to state that one can either say the crowd expects continued relative fair weather (S&P500), or one can say the crowd expects more misery (the bond market) -- I think he was cherry picking the bond market to bolster his views... I doubt it was an accident that he neglected to mention the S&P500.

This seems like more of a moral argument for buybacks (CEO as an implicit financial advisor). It's also beating around the bush. If the CEO is supposed to somehow guide investors, then why don't we expect him to say "we don't think the shares represent good value at this time", and just leave it at that. Sometimes the direct approach is overlooked. As my grandmother told me a few days ago "why make something simple when it can be made complex". We were chatting about the bureaucracy of my getting my Australian passport renewed at the time. Of course, one of the guarantors that I found had a lovely comparison between bureaucracy and a rhinoceros: you can't get around it and you can't offend it. Is the CEO the rhinoceros?

I only wish I could be his editor. He spends a lot of ink to say that buying cheap is better than buying dear -- well, "duh" Mr Lampert.

We take lower returns so that others can have more? This reminds me of my tax bill.

That's very helpful. And thanks to Bronco too. The IRS of course can't just write their rule in a clearer fashion.

It's funny how many people wonder without certainty why Buffett prefers to wholly own the businesses. I think it's fairly obvious why.

What's more likely... finding a quality money manager to just run your money (reinvest your dividends) for you if you are a poor allocator, or finding a CEO that not only has undervalued shares (reason why you own in the first place), but also runs his business in addition to knowing more about allocation than your genius money managers? And then you find out that this CEO wants to change the name of the business to his own, and swipe your cash flows as his "performance fee" or whatever crap he thinks up. Sometimes best to just hire the able capital allocator (money manager). Or if you are already a money manager, I suppose you could tell your clients that the CEOs know more about capital allocation than you do, so they'd better just find a more competent money manager in the first place. I find it frustrating when companies just sit on hoards of cash waiting for their shares to be undervalued so that they can return it to us common shareholder folk at long last. Their superior intellect of course informs them that we are better off to be treated this way. By the very implication of their saving dry powder for a buyback at such a moment, this must indicate that a wad of cash is just sitting there earning next to nothing in the meantime. They can start out looking like great value, which is why you buy them, but then later you find out they just want to stockpile the cash that you'd sort of figured was FREE CASH FLOW, but really isn't because it needs to rest for years to fund their ego. Meanwhile, there's all these other opportunities to purchase shares in other companies while we sit and patiently wait for the CEO god to find the right moment -- not all stocks are undervalued at the same time as we all well know. But the CEO god knows all, and can't possibly be missing the opportunities that we turn up. There's probably not a person on this board that can't allocate a dividend into a reasonable prospect when a given CEO can't find anything -- yet I find the people on this board more supportive of the idea of the all-knowing CEO. It's kind of ironic. Can you think of any companies you owned at the bottom of the market in 2009 where you would have liked these geniuses who know so much more than you to just give you a dividend so that you could take advantage? They were probably still buying back shares 9 months later furiously trying to deploy all that cash, even though the market price of the shares had already doubled. Point being, the bottom doesn't last that long -- not long enough for a company who can only buy 25% of the daily volume and where the company wants to purchase like 25% of the float or something. Generally if we're excited about a buyback opportunity we're talking about a MEANINGFUL and SIZABLE one right? The company with it's hands tied on volume is the absolute worst method of deploying cash this way at such a time -- except for taxes. Name any company you like -- I could have deployed any "special dividend" in seconds. It takes these guys months if not years to deploy the same amount of cash (on a per share basis) via buybacks -- just too many restrictions. Academically, it sounds enticing, but in practice these rules make it not quite so good. Then there is the factor of price -- all that buying by the company, does that support the price at all? In the absence of an official buyback program, could you get it cheaper with your dividend? After all, not everyone getting the dividend will reinvest in the same stock --- unless the company is doing it on your behalf.

1) Management can opportunistically time buybacks when stock is cheap (which could be at anytime throughout the year) but the dividend receiver has no such luxury What if the market crash happens during a blackout period and the company buyback plan misses the boat entirely or at least substantially? The management can pay the cash out faster than it can buy shares in the market. Shareholder can sit on the cash and wait for the right time. Management is restricted to purchasing something like 25% of the daily volume average -- the individual shareholder is not best served by such restrictions. I don't agree with management that feel they have to maintain a dividend when they can't afford one. They seem to desire a consistent payout, and this keeps them from bumping it up and down. They get too many questions otherwise and likely do it to make their professional lives more convenient. Microsoft however once managed a "special" dividend as did Leucadia -- don't see why such dividends are not more common, especially during market crashes when prices are cheap and there is too much cash to deploy in buybacks (I'm referring to that slow 25% accumulation rate). Eddie could have done a special dividend in late 2008 and early 2009 for example and shareholders could have grabbed more shares in a shorter period of time while the getting was still incredibly good. I'll bet the corporate pace of buybacks lags such an approach, but of course this is just my intuition again -- a "thought experiment". For an investment vehicle, I like the way Berkshire has been managed. He'll buy other non-Berkshire businesses -- the advantage here is that he has a zillion lifeboats he can sell if he ever needs cash. Somebody else trying to run an investment vehicle might take the attitude that his own stock being just as cheap as another stock, might buy more of his own stock. That person undervalues the importance of the lifeboats. If SHLD is an investment vehicle then I think he should be gobbling up more lifeboats. But if SHLD is merely an operating company, then Eddie is doing the right thing by just returning cash. Just another reason why I think he isn't running it as an investment vehicle.

Correct. Return to shareholders -- nothing more or less. No more so than to just buy more shares with the dividend. Is two quarters worth less than a 50 cent piece? It's more tax efficient in the buyback route -- but taxation is the only source of added value. Correct. To quote Malboussin: "You are making an active decision if you do not sell any shares while a company is buying back stock. Doing nothing is doing something— increasing your proportionate stake in the company by effectively reinvesting." The key fact is that he is "building value" for you via buybacks no faster than if you are getting more shares through a DRIP. So why does he do it? Probably he wants ESL to buy more shares, but he doesn't want to pay tax on a dividend in order to boost their stake. Whatever his motives for the buyback, my point is that it's just a tax-efficient dividend of your free cash flow. You can choose to hold your increased stake or sell -- no different from getting a dividend and choosing to buy more or not buy more. Sorry, but I like that so much I am going to repeat the question: Is two quarters worth less than a 50 cent piece? Forgive me if we're saying the same thing in different words but there are two questions as I see it. One concerns whether a reinvested dividend is theoretically and practically equivalent to a stock buyback. The second is whether stock buybacks can grow per share business value. Yes, well I don't disagree that per share business value goes up. But that's overrated -- I mean, compared to just having more shares. I don't see as I put it any advantage to your having 1 quarter that grows to 50 cents in value (via buyback), or instead just acquiring a second quarter (via dividend). When I comment that no special value is created, I'm referring to the alternative action which is to just return the cash as cash. Value investors are a funny lot -- you don't see them bragging about master capital allocators that pay dividends. Like "Oh my god man, that person is a genius because he paid a dividend so now I have purchased an additional share and therefore I now own more cash flow!". Either way you own more of the business cash flow... it's just a matter of tax, and somewhat a little bit trading costs. Value investors don't cut through the crap and just say "wow, Eddie saves us tax and trading costs"... no, they speak of the buybacks as if there is some value conjuring force at work. As if there is something special to SHLD other than the businesses it holds. And yes, it's true that SHLD is a portfolio of operating companies. So is Proctor & Gamble -- but we don't speak of PG as an investment vehicle. I don't know whether a study has been done, but I intuit that over the long haul you'll come off ahead (if you have sufficiently large positions) if they always just buy back shares and you sell an offsetting portion after getting the news on the amount and price. Right now the dividend tax rate is low, but when they restore it to prior levels it provides a large margin of safety between the price paid in the buyback and the price you sell it at a few months later. Over time it will wash out (sometimes you sell higher than they bought) and the tax benefit will largely put you ahead I suspect. Why in the hell would we ever own shares that were overvalued? So why ever worry about "paying too much" in a buyback? Sounds like an argument for academics, but not value oriented people like us who don't own overvalued stock right? Isn't that just simple investing sense?

Correct. Return to shareholders -- nothing more or less. No more so than to just buy more shares with the dividend. Is two quarters worth less than a 50 cent piece? It's more tax efficient in the buyback route -- but taxation is the only source of added value. Correct. To quote Malboussin: "You are making an active decision if you do not sell any shares while a company is buying back stock. Doing nothing is doing something— increasing your proportionate stake in the company by effectively reinvesting." The key fact is that he is "building value" for you via buybacks no faster than if you are getting more shares through a DRIP. So why does he do it? Probably he wants ESL to buy more shares, but he doesn't want to pay tax on a dividend in order to boost their stake. Whatever his motives for the buyback, my point is that it's just a tax-efficient dividend of your free cash flow. You can choose to hold your increased stake or sell -- no different from getting a dividend and choosing to buy more or not buy more. Sorry, but I like that so much I am going to repeat the question: Is two quarters worth less than a 50 cent piece?

I take it you don't think he's right about the following: But there is an important difference from the investor’s standpoint. With a dividend, all investors are treated equally. When a company buys back its shares when they are overvalued, on the other hand, there is a wealth transfer from the continuing shareholders to the selling shareholders. Symmetrically, when a company buys back undervalued shares there’s a wealth transfer from the selling shareholders to the ongoing shareholders. While the company may return the same amount of cash to shareholders through a buyback or a dividend, how value is distributed can be very different. He isn't saying anything wrong here. It could be restated as "automatic dividend reinvestment plans are a wealth transfer to selling shareholders from buying shareholders". I'd completely agree with that, if the shares are overvalued. If undervalued the wealth transfer would flow in reverse. So he is correct once more. The trick is to become one of the sellers. That's obvious, we already knew that.

The buybacks have been mentioned several times throughout this thread... I can't give him any credit for being a master capital allocator related to his buying back shares. No more so than a company that pays dividends is a master capital allocator. The buybacks are merely the return of cash flow. Stop thinking of the buybacks as any special recipe of value creation here. The only thing that matters is the price to cash flow. This other matter is a distraction. The only thing "masterful" about the buybacks is that he is returning the cash flow to you in recognition that he has NO MEANINGFUL USE FOR IT -- if that isn't an endorsement of SHLD as not being an investment vehicle, then I don't know what is. At least he is returning the cash flow instead of devaluing it via bad investments... that I'll give him credit for.

Yes, but what is the price of S&P500 telling you? Not to pick on you -- a lot of people say the bond market tells us this or that. What does it mean? What did the bond market tell us in 2006?

Only 16% of their assets in Spain/Portugal and most Latin American operations in the top 3 by country with ROEs in the 25% range. Currently priced at 1x BV. Precisely. I hope you get your next European scare (I will buy more).