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What Warren Buffett Means When He Says We Can Have Our Pie and Eat It Too

August 25th, 2008 . by economistmom

Well, a lot of I.O.U.S.A. moviegoers no doubt left the post-movie panel discussion on Thursday night a bit confused about Warren Buffett’s self-proclaimed “Pollyanna” view on the long-term fiscal challenges facing the U.S., when Buffett started talking “pie.”  From the written transcript (pages 8-10), emphasis added:

…there’s no question that the people in this audience, their children will live better than they do, and their grandchildren will live better than their children.  I mean, this is a marvelous economy…since 1982, we’ve added 25 million plus jobs in this country.  We are now exporting 12 percent of our GDP, which was five percent of our GDP in 1970…So…we will have a larger pie.  Now, we’ll have people fighting over who gets that pie.  I mean, there’s no question about it.  And we’ve made certain promises that promise away a portion of the pie.  But the wonderful thing is that the pie gets larger–even if one percent per year real productivity growth per capita, we double the GDP in per capita in real terms…[in] 75 years when the Social Security projections go up.  So even though seniors may get more of the pie, the pie will grow enough so that everybody will get more of the pie.

These words left the audience wondering:  was Warren Buffett saying we can have (i.e., keep) our growing “economic pie” and eat it (i.e., use it up, through growing demands for social programs and costs of debt service), too?  Was Buffett taking, in effect, a “don’t worry, be happy” attitude toward the terrifying trends just shown in the movie?  Was he saying, in effect, that “deficits don’t matter”?

Well, no, he certainly wasn’t saying that “deficits don’t matter”… this is the man who wrote the “Squanderville vs. Thriftsville” story and who once drove his car with the license plate “THRIFTY” on it (according to the Washington Post’s Frank Ahrens), after all.  What Buffett was expressing was the optimistic, but not ridiculously unrealistic (not really too Pollyannaish) view that no matter how and when we decide to take action on our fiscal challenge, we’ll do it before total economic disaster strikes, and that we’ll have a strong enough economy to be able to afford the adjustments needed to bring things back in order.  Buffett is saying that our longer term fiscal challenge will certainly “eat” more of our economic pie, but we’ll have enough of that (growing) pie to spare so that what we’ll be left with–or what our children will be left with–will still be an economic pie that’s larger than today’s economic pie.

But Buffett was not saying that putting off corrective actions isn’t costly–nor was he claiming that the kind of economic growth he describes could possibly keep up with compounded interest on the debt.  Nor was he failing to recognize the adverse feedback effects of unsustainable debt on the economy.  This was clarified in Buffett’s follow-up interview with CNBC on Friday morning, when he explained in part two of the interview:

…there’s nothing inappropriate about having debt in America. I mean, Berkshire has debt, and it’s helped us grow over time. And it’s when debt gets out of control that you worry. But the American democracy, it’s always fun to spend a little more than you take in, and that applies to individuals, it applies to governments. And in a $14 trillion economy, having debt that’s 60-odd percent of GDP is not inappropriate. It wasn’t inappropriate when we had 120 percent of GDP in debt after World War II, because we had to fight a war. …what you worry about is when the debt starts spiraling out of control, when it goes up year after year after year as a percentage of GDP, because eventually when that occurs people–if you try to borrow money around the world in your own currency, the world will say no. That’s what happened in South America in the past, it happened in the–in the Asian arena. We are able to borrow money in dollars. The world trusts the dollar. If we tried to run our debt up to 3- or 400 percent of GDP, nobody would want debt denominated in dollars.

And when he elaborated about that growing economic pie in part three of the interview (emphasis added):

…I think you should always be thinking about the future. I mean, I think you’re crazy if you’re not–if you’re not planning out where you’ll be in 10 and 20 or 30 years. You’ll get surprises in those plans… And frankly, American ingenuity will tend to surprise on the upside much of the time. I also think that it’s dangerous politically over time. It doesn’t endanger the economy in a huge way, but it’s dangerous politically over time to run very large current account deficits whereby there’s a massive transfer of assets or IOUs to the rest of the world from America. I think that will cause a lot of demagoguery and potentially some real problems 20 years down the road. We’d still have a more prosperous society… But it wouldn’t be–wouldn’t be as good as if we didn’t do it.

In other words, the economic pie left to our kids would not be as big as if we hadn’t run up so much debt.  In Buffett’s optimistic view, we won’t let it get to the point where our children’s economic pie would be smaller than our economic pie, but running persistent budget deficits is still a way that we parents choose to eat some of our children’s pie, today.

I’m convinced by the rest of Buffett’s post-IOUSA discussion that what Buffett really means when he emphasizes our large and growing economic pie is that we can afford to fix this fiscal problem–and that we can afford to start fixing it even now.  I’m convinced because the next thing he emphasized in the post-movie discussion was that there is plenty of capacity, even in today’s economy, for some people (like him) to pay higher taxes:

…every line in the tax code is important to some constituency…you’ve got thousands of lobbyists there protecting each line in the tax code…The tax code is an attempt by various interests, income– divided by income, divided by– demographics, all kinds of things, for people to get more of the pie. Now, the question was raised about savings and taxation. I’ve been a compulsive saver all my life, as my children will tell you. But I am paying the lowest rate of taxes on my income which comes from investments. I’m paying the lowest rate of taxes that I’ve paid in my entire life, including when I delivered papers. I am paying a 15 percent rate on dividends. I’m paying a 15 percent rate on capital gains. And there’s no payroll tax attached to that. [The] Cleaning lady [who] comes into my office has a 15.3 percent payroll tax that she’s incurring…Investors have never had it better in terms of taxes. I mean, you’ve got 401(k)’s which you don’t pay till many, many years in the future. You’ve got the lowest rate on dividends, capital gains. I['ve] worked in environments where capital gains [taxes were] raised [to] 39.6 percent, [and] employment grew, the economy grew. Nobody told me to go home at 3:00 because they pay so much tax by 3:00, [that] they didn’t want me to work until 5:00 or anything of the sort. So investors have it extraordinarily good. And they have it good, frankly, because they’ve lobbied for it. I mean, they have a strong constituency and my cleaning lady doesn’t.

and ten minutes later Buffett reminds the audience that as a society we do choose to make certain commitments as to what we think is worth spending our resources on, but we’ve always found the capacity to afford to pay the bills–and we will continue to find that capacity, even as many of us will continue to kick and scream about our own individual shares of those bills:

We said we’d promise Medicare to everybody when they get to a certain age. We promised a monthly check from Social Security. But we promised all kinds of other things, too. We promised we’re gonna defend this country. That’s gonna cost us hundreds of billions of dollars a year. That’s a promise to the American people…We promised we’re gonna educate our children. That’s hundreds and hundreds, trillion– probably in the trillions a year. So we have all kinds of promises for the future. But, fortunately, we have all kinds of productive capacity for to the future, too. So to isolate these promises because they happen to be in a given statute and to say we don’t have a promise to defend this country which is gonna cost hundreds and hundreds of billions of dollars, that’s a promise of the government just as well. So I think people get very hung up, frankly, on the promises that relate to so much per month or something like that. And we will have more and more goods and services in this country to deliver in one form or another for the American people. And we’ll fight in Congress about who gets what and the seniors will wanna get more…And people– other people will care more about the young. And other people, you know, will care more about national defense or whatever it may be. But the fortunate thing always to remember is that the pie gets larger all the time. And there is more to divide up. And then we have to fight it out as to who gets it.

So who does Warren Buffett think should get more of the “economic pie” as we “fight out” who gets it?  From the follow-up CNBC interview, it’s clear he thinks that more people like him will need to pay more in taxes, made even clearer by the fact that he’s an Obama supporter.  Buffett also admits that neither candidate has been brave enough to speak much about fiscal responsibility during this campaign season:

The one thing you won’t find…you won’t find either candidate telling you that if we’re going to spend $3.1 trillion next year, the federal government will tell you how they’re going to raise 3.1 trillion. They just aren’t going to come up with it.  [from part 3]

…[and this exchange from part 4 (emphasis added):]

Unidentified Woman [call-in to CNBC]: Hi, Warren. Identifying the debt problem and coming up with a solution seems like an easier task than motivating Congress. What would you suggest that we do to help motivate a shortsighted Congress?

[Becky] QUICK [CNBC]: OK. That’s, again, going back to how do you motivate a shortsighted congress. What would you suggest?

BUFFETT: It’s very tough. I mean, in the end, can I name a politician in the last 20 years that said, `My campaign is I’m going to increase your taxes a lot and come close to closing the budget deficit.’ And since nobody wants spending cut–they all want the other guy’s spending cut…

QUICK: Mm-hmm.

BUFFETT: …and, you know, we’ll have to increase taxes. I–Walter Mondale tried it in 1984 without much success. Now, what I do with politicians is I ask them what they believe in and will work for that a majority of their constituents oppose. Now, if they give me an answer to that, I know they really believe that. I mean, I don’t get long answers to that question. But what they…

QUICK: I bet you don’t.

BUFFETT: Yeah, no. But that’s the real test of what they believe in. Anybody’s for anything that gets them elected, so if they–if they say, `I’m for lowering your taxes,’ or `I’m for bringing all kinds of things to my district,’ or `earmarking things,’ you know, of course they’re going to say that. And they’ll say that whether they believe in it or not because it keeps their jobs. Now, the question is what do they believe in that might endanger their job if in–if done?

QUICK: What did Barack Obama say when you asked him that question? You’re supporting him.

BUFFETT: Yeah. I’m not going to ask him that question.

QUICK: You haven’t asked him that question.

BUFFETT: No, I didn’t–I didn’t–I didn’t put that one to him.

QUICK: Why not?

BUFFETT: I didn’t feel like putting him on the spot that way.

QUICK: But he got your support anyways.

BUFFETT: Well, I have a choice of two candidates…

QUICK: Right.

BUFFETT: …and I support Barack and I think that on balance he will be better for America. Although I admire John McCain as an individual, but I think that Barack would be better. But I will–I can tell you that both candidates are not addressing things in the campaign that are important issues, because they feel it’ll cost them votes.

QUICK: What do you think is the most important issue that’s not being addressed by either campaign?

BUFFETT: Well, I think in the–certainly in the financial area. Now, they’ve both made certain proposals on taxes, but in terms of the realism of what would happen in terms of closing budget deficits or something of the sort, I don’t think they really want to get that specific about it now.

So I think Warren Buffett means we can have our pie, and eat it, too, but hopefully once the next President takes office, we can start to think more carefully about how much of the pie is worth eating now, versus having more of it to eat later.  Clearly, Buffett still believes that saving for the future can be consistent with enjoying life today, with enthusiasm and optimism.  And he’s certainly good testimony for the wisdom of that attitude. 

(Stay tuned for a more quantitative analysis of the Buffett “economic pie” point later this week.)

4 Responses to “What Warren Buffett Means When He Says We Can Have Our Pie and Eat It Too”

  1. comment number 1 by: B Davis

    Buffett is saying that our longer term fiscal challenge will certainly “eat” more of our economic pie, but we’ll have enough of that (growing) pie to spare so that what we’ll be left with–or what our children will be left with–will still be an economic pie that’s larger than today’s economic pie.

    I agree. The first graph at this link shows that receipts (and to a lesser degree, outlays) have been fairly stable as a percent of GDP since 1950. It occurred to me that keeping both receipts and outlays stable and approximately equal to each other would generally allow taxpayers and recipients of government benefits to both partake in the growing pie. Since wages tend to grow with GDP, a stable level of receipts can generally be achieved with a stable tax rate. If wages grow in real terms and taxpayers keep the same percentage of their wages, then their after-tax income will grow in real terms. Likewise, if outlays remain at a stable level of GDP, they will be growing in real terms.

    Of course, all of this is on average. In addition, the aging of the population will surely require that a somewhat larger percentage of receipts go to entitlements. Still, it does seem that we can design policy such that all groups benefit from the growing pie.

    In other words, the economic pie left to our kids would not be as big as if we hadn’t run up so much debt. In Buffett’s optimistic view, we won’t let it get to the point where our children’s economic pie would be smaller than our economic pie, but running persistent budget deficits is still a way that we parents choose to eat some of our children’s pie, today.

    I hope that we are wise enough not to let it get to the point where our children’s economic pie would be smaller than our own. Of course, financial problems can be very difficult to control when they get out of hand. One way to insure that they don’t would be to simply not eat any of the next generation’s pie, except as an investment or in an emergency. It doesn’t seem to me that our forefathers “ate our pie” (except in those cases) so I don’t know if we should be eating the pie of our children.

    In any event, it does seem good to point out that there will be a price, that “the economic pie left to our kids would not be as big as if we hadn’t run up so much debt”. Financial disaster and perpetual prosperity are not the only possibilities. We may simply become a second-class power or just become something less that we might have been. Perhaps we will become known as the so-so generation. Not much of a legacy to leave.

  2. comment number 2 by: Brooks

    B Davis,

    Financial disaster and perpetual prosperity are not the only possibilities. We may simply become a second-class power or just become something less that we might have been.

    Picking up on that point, it is important to determine via analysis this matter of degree: Assuming spending proceeds as currently projected (which seems to be Buffett’s premise, although I could be wrong about that), where Americans would be along that continuum if we wait X years before starting to balance budgets or coming closer to it vs. if we wait Y years or get started right away.

    Ideally, it would be useful to see a baseline of real after-tax per capita GDP if we immediately get on and stay on the most fiscally responsible course possible given the constraint of spending per current projections (e.g., raising taxes as a % of GDP sufficiently to balance the budget in F2010 or whatever). That baseline could be compared to trend lines for real after-tax per capita GDP under scenarios of waiting X or Y years before adopting policies to produce those optimal levels of annual fiscal balance. Thus, we could see both the opportunity cost of delay and, if real after-tax per capita GDP actually declines vs. today, the actual cost of delay. Or put differently for general public consumption, assuming spending levels proceed as currently projected, we could see how much better off Americans would be if we do not delay paying for this spending, and possibly also how much worse off Americans will be vs. today if we delay paying for it.

    Just for illustration, if:
    Current GDP per capita is $46,000
    Current tax revenues are roughly 20% of GDP
    Current after-tax GDP per capita is $36,800.

    Then if tax revenues at some point a few decades from now are 35% of GDP (covering the higher level of spending):
    - If real (pre-tax) per capita GDP has grown to $70,000, then real after-tax per capita GDP — $45,500 — is higher than today (albeit not as high as it would have been had spending been paid for to a greater extent sooner — e.g., the baseline projection).
    - If real (pre-tax) per capita GDP has grown to only $50,000, then real after-tax per capita GDP — $32,500 — is lower than today (so it is not not as high as it would have been had spending been paid for to a greater extent sooner, but actually lower than today).

    Yes, there is also the matter of income distribution (as opposed to just the average). Also, there is the question of impact on national wealth as opposed to annual income (GDP). And his premise (as I understand it) is that spending proceeds per projections, and of course that premise could be altered for further comparison of projected real after-tax per capita GDP. But Buffett’s argument related to GDP per capita under current spending projections (I think), and at least the first step should be to address it on its terms.

    Of course, particular assumptions are key (e.g., GDP growth rates), but sensitivity analysis can be conducted for such variables.

    I took a whack at some scenarios last night by putting together a spreadsheet, but I don’t know if my spreadsheet constitutes an appropriate framework, nor that my assumptions are valid, since I’m not an economist. I look forward to Diane’s analysis, both for what it reveals/implies and to see how her methodology and assumptions differed from mine, since unlike me, she knows what she’s doing.

  3. comment number 3 by: L. Smith

    The main reason why education today is so expensive is because we are committed to using an infrastructure that is very costly. No only is it expensive to operate but because we mistakenly think that we’re committed to the traditional model of group education, this infrastructure is almost prohibitively expensive to improve and modernize. What we need is an entirely new approach to education that addresses the real problem, namely how to do right by our children. We should not be distracted by trying to sustain the schoolhouse infrastructure or worry about the future and security of our teachers as much as we should be worrying about whether we are providing for our children properly. The first rule is “to do no harm.” It’s hard to say that in our approach today that we are doing anything other than pay lip service to this sacrosanct rule. Take a look at the innovative, affordable, and actionable treatment of our education problem provided in the commission report, “Education in America — What’s to Be Done?” developed by Trigon-International.

  4. comment number 4 by: Cleaning Lady

    Nice and usefull post, thanks, this is one for my bookmarks!