Feb 13th, 2007 by Martin Lee
The amount of federal income tax that Berkshire pays (either directly or indirectly) is about 0.5% of the total paid by all American corporations. Their 1993 direct federal income tax comes up to $390 million, about $200 million from operating earnings and $190 million from realized capital gains.
Another $400 million of federal and foreign income tax is contributed by their investees, a figure that can’t be seen on Berkshire’s financial statements.
Warren Buffett and Charlie Munger prefer having a buy-and-hold policy. This is the soundest way to invest and taxes are due only when gains are realized.
Imagine you take a dollar, invest it in company A and it doubles in value after one year. Now, you sell the investment, invest it in company B and it doubles again. Repeat for 20 years and your investment will become $1,048,576. If a capital gains tax of 35% has to be paid every year, the amount will only have increased to $22,370 after 20 years. Another 7.5 years would be needed for it to exceed a million dollars.
On the other hand, if you hold on to a single investment and let it double by itself every year, you will end up with about $200 million pretax after 27.5 years. After paying a tax of $70 million, you will still be left with about $130 million.
You will realize a far, far greater sum from a single investment that compounds internally at a given rate than from a succession of investments compounding at the same rate.