There is a battle in politics and the media going on about what the future tax rates should be and whose rate should change. President Obama and Warren Buffet are on the side that believes that the wealthy should pay more for numerous reasons. And there are political opponents who are arguing that no one should pay higher rates, especially wealthy business owners who are presumably the ones who will create the jobs that are the main goal of Obama’s Jobs Bill.
There are people who articulate the politics of this issue well enough that make it unnecessary for me to go into it here. In this article I will discuss how this issue has been misunderstood in the media, and what you should know about it concerning your own finances.
Socialism Vs. Capitalism
Unfortunately, the mass media makes mistakes in how this issue is portrayed. The most common one is that they make a link between income and wealth that isn’t as strong as they believe. There are reams of studies, political papers, and opinion written about how social standing, health care outcomes, etc are determined by your income. It’s deafening. I’ve read many newspaper articles and OpEds over the years that use the idea of income and wealth interchangeably.
People who make large incomes are not necessarily wealthy. What makes someone wealthy is what they own, not what they earn.
This misunderstanding is rooted in the difference between socialism and capitalism. In both economic systems, people earn incomes and how much they earn is determined by skills, experience, and training to varying degrees. However, in a capitalist system, the capital goods such as equity, equipment, financial instruments are generally owned by private entities whereas in a socialist economy they are owned and managed by the collective. In a Socialist system, the fight is on income because no one can own capital assets where the real wealth is.
Warren Buffet made $40M of income that was taxable, yet this is less than 1% of his total wealth. What makes Buffet wealthy isn’t that income it’s the huge stake he owns in his company, Berkshire Hathaway that is over 100X larger than his declared yearly income. Journalists usually make no mention of this either because they don’t understand capitalism or how it works. If one really wanted to tax the wealthy, the right place is to go after their wealth not their income.
- Mass media influences public policy and they are generally antagonistic towards people who earn large incomes and muted on true sources of wealth. Focus your efforts on activities to accumulate assets that will make you wealthy. As the balance sheet of Warren Buffet shows his assets are the real story and not his income.
- We live in a mostly capitalistic society so the engines of the economy (including Warren Buffet’s company) are for sale for anyone to own. This is the best way to achieve financial independence, buying assets that will growth and make you money over the long term.
- Don’t concern yourself too much with these battles because the combatants are fighting over issues that are not front and center concerning the ones you need to focus on to achieve financial independence.
Determine Your Personal Wealth Factor
Buffet is one of the richest persons in the world. His income is very small compared to his assets. This naturally leads to determine a method to compare anyone’s wealth to Buffets. This is not a simple total of wealth, but a ratio of your income to your assets. If your assets are large relative to your income and they are growing faster than your income then you are on the right track. Here’s the calculation:
Wealth Factor = ( Assets – Liabilities / Earned Income )
In Buffet’s case, his assets are 40B. It can only be guessed what his actual earned income is, but it is most likely much less than his reported income of 40M because a lot of that is probably unearned, or investment income. According to SEC filings Buffet’s income from Berkshire is only 524K.
For Buffet, his Wealth Factor is 75,000. When calculated for the author, it’s 7. There is a long way to go!