The Snowball

by Alice Schroeder

  The more serious, if smaller, problem was Dexter Shoe, the modern equivalent of the textile mill. Buffett would later say it was the worst acquisition he had ever made, quoting Bobby Bare’s country song: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”24 He changed the management. Frank Rooney and Jim Issler, who ran Brown Shoe Company, a more successful operation, eventually shut down Dexter’s U.S. operations and moved them overseas.25 For every dollar they were paying workers in the U.S., it cost a dime to hire employees to make shoes elsewhere.

  “I was wrong about the economic future of that one. The people working in the town of Dexter, Maine, were wonderful people who were very good at what they did. But even if they were twice as good as the Chinese, the Chinese would work for a tenth as much.”

  Yet even with all this money-spinning activity, Buffett felt that the most important opportunity given him in the aftermath of 9/11 had nothing to do with business. Rather, he now had both the privilege and the responsibility to use his pulpit to influence events and ideas. After the bubble of hubris that had enveloped the financial community for the past several years, America had become more sober-minded, and less blind to the corner-cutting in the name of greed that had gone on in the late 1990s. Buffett thought the time was right for him to speak up about the rapacity of the rich and the way it was being validated by fiscal policy.

  His sense of justice was particularly inflamed by a proposal that was a centerpiece of President Bush’s new budget—a plan to gradually repeal the decades-old federal estate tax, which took for the government a slice of the largest inheritances. Supporters of the plan referred to the estate tax as the “death tax,” which had an ominous sound. The mantra was that death shouldn’t be a taxable event. They called the estate tax a barrier to the ambitions of hardworking entrepreneurial people. They cited a proverbial family that would have to sell the family farm to pay the tax when its patriarch died. Undoubtedly, there were some such families. Buffett argued that the suffering of those few was far outweighed by the effect on everybody else.

  The estate tax was technically not a death tax; it was a gift tax. Anytime someone gave a large gift of money, he paid a gift tax.26 All gift taxes were a blockade against the return of the robber barons, who controlled so much of the nation’s riches through gifts and inheritance in the nineteenth century that they became like a government unto themselves—a plutocracy—a ruling class based on wealth. The estate tax, however, was paid at a lower effective rate than the tax imposed on gifts from living persons, allowing relatively large posthumous gifts to go untaxed. Buffett used his preacher’s pulpit to point out that of the roughly 2.3 million Americans who died each year, fewer than fifty thousand—two percent—paid any estate tax at all. Half of all the estate taxes paid came from fewer than four thousand people—two-tenths of one percent of those who had died.27 These were the monumentally, colossally rich, rich on the scale of being able to own a Gulfstream-IV, buy the new Maybachs, own a vineyard in France, and wear jewels that look like rock candy and lemon-and-lime sourballs.

  As to the question, it was their money, why shouldn’t they be able to do what they wanted with it?—why should they “subsidize” others?—Buffett’s answer was that they owed some minimum amount to the society that enabled them to become so rich. If they thought they did it all themselves, reincarnate them as one of five children of a scared, starving mother in Mali and see how rich and successful they would be after being sent to work as a slave on a cocoa plantation in Côte d’Ivoire.

  If the estate tax were eliminated, he said, somebody else would have to make up the difference, since the same amount of money would still be required to pay for running the government.

  For years a supply-side theory had postulated that cutting taxes would force the government to cut expenses. This theory had an intuitive logic; after all, if people were supposed to live within their income, why not the government? (Of course, by 2002, the populace was busy setting up home-equity lines of credit based on artifically cheap interest rates to avoid living within its income.) Debate over supply-side policy still boiled after twenty years; the taxes the government was collecting usually didn’t cover its costs, and it was borrowing to make up the difference. The theory by now looked more dubious. Killing the estate tax would mean that the government would have to raise taxes or borrow even more money, and the interest on that debt, along with its ultimate repayment, would eventually be passed on to everybody else in the form of higher taxes. Buffett felt that proposing an estate-tax cut while running the federal budget at a deficit was, in fact, the height of hypocrisy.28

  The average person who would pay these higher taxes if the estate tax were repealed would never face an estate tax. The push to repeal the estate tax was not coming from people who owned small ranches in Oklahoma. No, the real push, Buffett said, was coming from a tiny percentage of the country’s population, people he actually knew, people who were rich enough (often very suddenly rich enough) to own a triplex penthouse in Manhattan, a nine-bedroom log cabin in Deer Valley, a summer house in Nantucket, and a condo in Costa Rica. Buffett felt that politics had slithered into the hands of people who could pay hush-puppy lobbyists from K Street to whisper in the ear of Congress and funnel political donations where they would do the most good. He didn’t blame people for acting in their own interests; he even felt pity for the politicians who were chained to the grindstone of endless fund-raising. It was the system that he scorned, in which money bought power.

  Shortly after President Bush’s inauguration in 2001, Buffett had gone to the LBJ Room in the Capitol Building to speak about political campaign financing to a group of thirty-eight Senators who were part of the Democratic Policy Committee, then followed up with appearances on ABC’s This Week and CNN’s Inside Politics. Buffett said that the campaign finance system was corrupt. The current way of electing politicians had echoes of nineteenth-century Tammany Hall, where votes and influence were literally for sale. The laws were shifting in ways that enhanced the ability of the rich to get ever richer, to keep more of what they made, and to pass more of it along to their heirs. Buffett called this “government by the wealthy, for the wealthy.”

  He pointed out a growing army of hush-puppies and tax panderers whose job was to push for legislation that benefited the interests of the rich. He said, however, that nobody lobbied for the other ninety-eight percent of Americans. Lacking their own lobbyists, the best redress for the ninety-eight percent was to understand what was going on and to quit voting for people who enacted laws that took taxes out of the average person’s pockets so the rich could pay a lower share.

  Paul Newman, Bill Gates Sr., George Soros, a smattering of Rockefellers, and nearly two hundred other rich and influential people agreed and signed a petition published in the New York Times that opposed Bush’s plan to eliminate the estate tax.29 Buffett didn’t join the petition because he thought it did not go far enough. He thought that rich people were lucky and blessed, and they should pay taxes. “I don’t believe in dynasties,” he said. Repealing the estate tax would be like choosing the nation’s Olympic teams from the children of past Olympic champions, he added.30

  “Wealth is just a bunch of claim checks on the activities of others in the future. You can use that wealth in any way you want to. You can cash it in or give it away. But the idea of passing wealth from generation to generation so that hundreds of your descendants can command the resources of other people simply because they came from the right womb flies in the face of a meritocratic society.

  “I’d have a higher tax at the higher levels of wealth. I wouldn’t mind having no tax up to a point and then a hundred percent tax for an estate over a hundred and fifty million dollars.

  “The most important thing is to ask, ‘And then what?’ If you eliminate the twenty billion dollars or so raised by the estate tax, you’ve got to make the money up by taxing everybody else somehow. It’s amazing how hard the American population will fight f
or the families of those few thousand people who pay large estate taxes and for the whole rest of the country to pay for it out of their own pockets.

  “I don’t like anything that, in effect, creates a residue of humanity. I don’t like a tax system that goes in that direction; I don’t like an educational system that goes in that direction. I don’t like anything where the bottom twenty percent keep getting a poorer and poorer deal.”

  But the debate over estate taxes turned shrill and bitter. Buffett was portrayed as a silver-spooned populist, a rich old crocodile who was trying to keep the next generation from bootstrapping its way to success in the classic American entrepreneurial manner.31

  “Dynastic wealth turns a meritocracy upside down,” he wrote to Senator Ken Salazar. “In effect it says that the people who should allocate the resources of this country should be the descendants of those who excelled in amassing resources long ago.”32

  Subtly or not, the estate tax feud was informed by the issue of Buffett’s own money. Some people called rich guys like Buffett tax-dodgers, because they had amassed their money through lightly taxed investments. But to say that Buffett invested to dodge taxes was like saying that a baby drank its bottle to fill its diapers. Indeed, Buffett was the first to say that the tax on investments was unfairly low. In fact, this was another of his causes. He liked to compare his tax rate to his secretary’s, pointing out how unjust it was that she paid a higher tax rate on her income than he did, just because most of his income came from investing.

  Having already angered all the plutocrats and would-be plutocrats, but with his credibility at a peak in other quarters, Buffett vowed to carry on the fight against repeal of the estate tax, and would spin on this subject for years. He spoke again on another subject to the Democratic Policy Committee just days before the first shots were fired in the Iraq War in 2003. He said that President Bush’s plan to cut taxes on dividends was more “class welfare for the rich.” In the Washington Post, he wrote about “Dividend Voodoo,” noting again that his tax rate was lower than Debbie Bosanek’s. The reaction from conservatives against yet another of Buffett’s populist manifestos was swift and savage. “Millionaires are seething at Warren Buffett’s betrayal of their class,” said one.33

  That, of course, was his point. He felt that the United States of America was never meant to be a country where people with money were a self-perpetuating “class” who constantly gathered more wealth and power unto themselves.

  The rich, however, had been getting very rich indeed as the stock market continued its resurgence after 9/11. A dozen new hedge funds seemed to sprout every day. They were cashing in on all the leverage from the low interest rates the Federal Reserve had provided. So many people were raking in stock options and taking fees of two-and-twenty percent of other people’s money in private equity funds, hedge funds, and funds of funds, that billionaires were becoming as common as raccoons around a garbage can. A lot of the quick-bucks wealth of the new economy bothered Buffett because of the way it had been transferred in massive amounts from investors to middlemen without producing anything in return. The average investor was still getting—of course—the average return, but with all of these fees gouged out.

  One of Buffett’s least favorite ways for the rich to get richer was through stock options—since his famous “no” vote on the pay package at Salomon, no other board had ever asked him to serve on its compensation committee. Coca-Cola had given Doug Daft options on 650,000 shares of its stock in 2001. Daft had originally asked to be compensated with stock options that would pay off only if earnings increased fifteen to twenty percent. The shareholders approved it with Buffett staring at his shoes thinking, Okay, this will never happen. A month later, the compensation committee belatedly realized that the target was impossible and Daft would never get paid. It backtracked and bonus-pimped for him, lowering the target to eleven to sixteen percent.34 That was like moving the finish line in a marathon to the nineteen-mile mark. Buffett couldn’t believe it—the shareholders had voted for twenty-six miles and would be handing out a prize after nineteen! Another vote for the rich. So far, Daft had not impressed, and Coca-Cola’s stock had gone nowhere. Watching trophy-sized option payments proliferate despite rising outrage, Buffett felt he had to seize the opportunity he had been waiting for—to finally kill counterfeit stock-option accounting.

  Managers loved stock options because of a quirk of accounting history that said that if companies paid their employees with options instead of cash, they booked no cost. It was as if the stock options did not exist. In the “real” world, a privately owned business would instantly recognize this as a bogus idea. If the butcher, baker, and candlestick maker gave away options for shares worth, say, twenty percent of their businesses, they would be acutely aware that they had just given away a chunk of the profits as well.

  But the accounting rules had made stock options into play money. Thus, bonus-pimping on an incredible scale had begun to occur in the late 1990s. CEOs had, on average, been paid forty-two times as much as the average blue-collar worker in 1980. Twenty years later, that ratio had increased to more than four hundred times.35 The top-earning CEOs got billion-dollar packages. In 2000, Sandy Weill was paid $151 million at Citigroup, Jack Welch $125 million at GE, Larry Ellison $92 million at Oracle. Although Steve Jobs was taking only a $1 salary at Apple for 1997 through 1999, he got a windfall $872 million stock-option grant in 2000—plus a $90 million Gulfstream jet.36

  When the accountants had tried to change these rules in the early 1990s, corporate America, led by Silicon Valley, stormed the gates of Congress, armed with lobbyists and campaign contributions, begging their representatives to save them from the terrible new accounting rules. Until the bubble finally burst in 2002, they had succeeded in stopping those rules dead in their tracks and had almost succeeded in murdering the Financial Accounting Standards Board, the accounting rulemaker, to boot.

  Buffett had been writing about stock options since 1993 but now felt the time was finally ripe for change. He wrote a thundering, influential editorial in the Washington Post, “Stock Options and Common Sense.”37

  “CEOs know what their option grants are worth. That’s why they fight for them,” he wrote, and repeated the questions he had raised before.

  “If options aren’t a form of compensation, what are they?

  “If compensation isn’t an expense, what is it?

  “And if expenses shouldn’t go into the calculation of earnings, where in the world should they go?”

  At Sun Valley in July 2002, emotions ran high over stock options. Buffett’s loudly expressed view, combined with his influence, hung ominously over the heads of the stock-option lobby. The thermometer hit triple digits, and the sweating celebrities and corporate chiefs headed off in buses to go rafting and escape the heat.

  Buffett himself went somewhere else shortly after he arrived, somewhere he needed help to face. Katharine Graham’s condominium had been right next to Herbert Allen’s, in the Wildflower group, a spot that people passed by often on their way to and from events. The Coca-Cola board would be convening later for a meeting at Allen’s, since most of its members were on site. The purpose was to discuss stock options, and he would not miss this. But first:

  “I was with Bill and Melinda, and we went up to the spot where Kay fell. I wasshaking, and I couldn’t stop. It was like I had the chills or something. And, you know, they were probably embarrassed. I really wasn’t. I was just overcome at that point.”

  Afterward, Buffett was able to perform his ongoing miracle of the bathtub memory, and carried on with composure. The Coca-Cola board made a decision during its meeting and announced in a press release that it would start to book the cost of its employee stock options as an expense, which was currently allowed but not required. Nobody else did that. They used an argument like the kid who tells his parents: It didn’t happen, but if it did I wasn’t there. And if I was there, I didn’t do it; and if I did, my friends made me. Businesses said tha
t stock options weren’t an expense; but if they were an expense, nobody knew how to calculate it. And if they could, the expense shouldn’t be deducted from earnings. It should only be disclosed in a footnote. Because it might confuse investors to know just how much the executives’ stock options were worth. So Coca-Cola’s announcement hit corporate America like a cluster bomb, its force magnified by the venue at which the new policy was proclaimed—the Sun Valley gathering where the press had dug in outside its flowerpot barricades like an encampment. Buffett’s thinly veiled hand could be seen behind this announcement. Right after Sun Valley, the Washington Post Company emulated Coca-Cola and announced that it, too, would expense stock options.38 Buffett followed up this victory with another salvo, a New York Times editorial, “Who Really Cooks the Books?”39

  “I have a proposition: Berkshire Hathaway will sell you insurance, carpeting, or any of our other products in exchange for options identical to those you grant yourselves. It’ll all be cash-free. But do you really think your corporation will not have incurred a cost when you hand over the options in exchange for the carpeting?”