Suitably Flip

Romney's Real Income Tax Rate: Somewhere Between 66% and Infinite

By now, you've doubtless been whipped into a dutiful lather over the fact that Mitt Romney incurs a tax rate of close to 15%, well above the 0% paid by half of Americans, but somehow alleged to be far lower than that of "most Americans" (15% is actually higher than the effective rate paid by more than 80% of Americans, whose marginal rates are no higher than 15%).

Still, we like to see our greedy millionaires getting whacked with astronomical effective tax rates, so 15% is woefully unsatisfying.

What's often glossed over (and frequently misunderstood, deliberately or otherwise) by weighers-in is the fact that the majority of Mitt Romney's "income" comes from capital gains on his investments, which are appropriately taxed at a lower rate than regular income for big earners.

Romney is said to make around $350,000 in speaking fees, which would subject to him about $81,000 in federal income tax (around 23%).  For his capital gains (taxed at a flat 15%) to be large enough to drag his effective rate down to - say - 17%, they would need to be at least $1,000,000.

That would make his total federal tax burden around $230,000 (17.1% * $1.35 million).  If his effective rate were as low as 16%, it would suggest he paid around $450,000, with capital gains totaling $2.5 million.  For the effective rate to actually hit 15%, his capital gains would need to be infinite (as would his tax burden).

What this analysis leaves out is the consideration that capital gains are not regular income (which, of course, is why they're not taxed as regular income).  There's a credible argument to be made that capital gains should be taxed at 0%, since this money is already taxed not once, but twice.

Income generated from corporate dividends is paid with after-tax corporate income (unlike your paycheck, which your employer pays out of pre-tax income).  Likewise, if you realize a gain from the sale of a stock, its appreciation during your holding period is simply a reflection of the market's increased estimate of the present value of all future after-tax earnings (ultimately realizable through after-tax dividends) of that company.  And the money you used to invest in that company was money you were already taxed on when you earned it.  Yes, that money may have in turn been made through earlier capital investments, but that only means it had already been double-taxed multiple times.

So if you want to drill down to the real effective tax rate Mitt Romney (or any succesful investor) pays, you might want to look at the cash tax outflows as a percentage of earned income.  In the above example ($230,000-450,000 on regular income of $350,000), this would come out to 66-130%.  And that's before state and local jurisdictions take their cut.

The closer his reported effective rate gets to 15%, the higher the real effective tax rate on earned income goes, without limit.

This of course does little to quiet those who insist on seeing wealthy investors paying at least as much money as high a percentage as the average American the top fraction of the top 20% who incur effective rates of 15% or more.  Else, this sub-"fair share" leads to an obscene concentration of wealth among those who are doing little productive work and are robbing the Treasury blind at the expense of those in the lower marginal brackets.

Again, this willfully ignores the fact that the wealth being generated has already been doubly taxed (at least once).  It also doesn't consider the reason we tax investment income at a lower rate (0% in lower brackets), namely to encourage (or, rather, to limit the extent to which we discourage) investment in productive enterprise.  It also neglects the fact that such investments incur risk of loss (unlike earned income), which cannot be used to offset taxes on regular income (beyond $3,000) in the same year.  So a 10% gain becomes an 8.5% gain, while a 10% loss remains (very nearly) a 10% loss, at best recouped to 8.5% in later years.

Romney's opponents on both sides of the aisle show few signs of backing off of making class warfare the dominant issue of the campaign.  And in an environment where even simple numbers like the unemployment rate are bent out of recognition (the DNC chair insists 8.5% is lower than 7.6%), there seems to be little chance that the complexities and implications of taxation will receive better than a wildly distorted, soundbite-driven, class-baiting treatment over the next 10 months.

If it's your preference to demonize the investing class in general, and private equity investors in particular, just bear in mind that Mitt Romney and Barack Obama both engage in this activity, the only differences being that Romney's limited partners are willing participants, unlike Obama's tax-paying constituents, and that Romney has been successful at it.

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Romney's Real Income Tax Rate: Somewhere Between 66% and Infinite

By now, you've doubtless been whipped into a dutiful lather over the fact that Mitt Romney incurs a tax rate of close to 15%, well above the 0% paid by half of Americans, but somehow alleged to be far lower than that of "most Americans" (15% is actually higher than the effective rate paid by more than 80% of Americans, whose marginal rates are no higher than 15%).

Still, we like to see our greedy millionaires getting whacked with astronomical effective tax rates, so 15% is woefully unsatisfying.

What's often glossed over (and frequently misunderstood, deliberately or otherwise) by weighers-in is the fact that the majority of Mitt Romney's "income" comes from capital gains on his investments, which are appropriately taxed at a lower rate than regular income for big earners.

Romney is said to make around $350,000 in speaking fees, which would subject to him about $81,000 in federal income tax (around 23%).  For his capital gains (taxed at a flat 15%) to be large enough to drag his effective rate down to - say - 17%, they would need to be at least $1,000,000.

That would make his total federal tax burden around $230,000 (17.1% * $1.35 million).  If his effective rate were as low as 16%, it would suggest he paid around $450,000, with capital gains totaling $2.5 million.  For the effective rate to actually hit 15%, his capital gains would need to be infinite (as would his tax burden).

What this analysis leaves out is the consideration that capital gains are not regular income (which, of course, is why they're not taxed as regular income).  There's a credible argument to be made that capital gains should be taxed at 0%, since this money is already taxed not once, but twice.

Income generated from corporate dividends is paid with after-tax corporate income (unlike your paycheck, which your employer pays out of pre-tax income).  Likewise, if you realize a gain from the sale of a stock, its appreciation during your holding period is simply a reflection of the market's increased estimate of the present value of all future after-tax earnings (ultimately realizable through after-tax dividends) of that company.  And the money you used to invest in that company was money you were already taxed on when you earned it.  Yes, that money may have in turn been made through earlier capital investments, but that only means it had already been double-taxed multiple times.

So if you want to drill down to the real effective tax rate Mitt Romney (or any succesful investor) pays, you might want to look at the cash tax outflows as a percentage of earned income.  In the above example ($230,000-450,000 on regular income of $350,000), this would come out to 66-130%.  And that's before state and local jurisdictions take their cut.

The closer his reported effective rate gets to 15%, the higher the real effective tax rate on earned income goes, without limit.

This of course does little to quiet those who insist on seeing wealthy investors paying at least as much money as high a percentage as the average American the top fraction of the top 20% who incur effective rates of 15% or more.  Else, this sub-"fair share" leads to an obscene concentration of wealth among those who are doing little productive work and are robbing the Treasury blind at the expense of those in the lower marginal brackets.

Again, this willfully ignores the fact that the wealth being generated has already been doubly taxed (at least once).  It also doesn't consider the reason we tax investment income at a lower rate (0% in lower brackets), namely to encourage (or, rather, to limit the extent to which we discourage) investment in productive enterprise.  It also neglects the fact that such investments incur risk of loss (unlike earned income), which cannot be used to offset taxes on regular income (beyond $3,000) in the same year.  So a 10% gain becomes an 8.5% gain, while a 10% loss remains (very nearly) a 10% loss, at best recouped to 8.5% in later years.

Romney's opponents on both sides of the aisle show few signs of backing off of making class warfare the dominant issue of the campaign.  And in an environment where even simple numbers like the unemployment rate are bent out of recognition (the DNC chair insists 8.5% is lower than 7.6%), there seems to be little chance that the complexities and implications of taxation will receive better than a wildly distorted, soundbite-driven, class-baiting treatment over the next 10 months.

If it's your preference to demonize the investing class in general, and private equity investors in particular, just bear in mind that Mitt Romney and Barack Obama both engage in this activity, the only differences being that Romney's limited partners are willing participants, unlike Obama's tax-paying constituents, and that Romney has been successful at it.