A lot of journalists are claiming that Romney would pay close to zero taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es under Paul Ryan’s 2010 Budget. In that year, Ryan proposed a budget that would eliminate taxes on all investment income. This would certainly benefit Romney, since nearly all of his income is from investments. However, Ryan no longer proposes that. His most recent budget calls for a continuation of the current policy regarding investment income, i.e. a 15 percent rate on dividends and capital gains.
Much more misleading and disturbing is the fact that none of these journalists recognize the extent of double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. in our tax code, particularly on investment. We don’t have Romney’s tax returns from when he was a kid or in college or beginning his career, but presumably Romney worked mainly for wages back then and was taxed accordingly. When Romney began his career at Bain in 1977 the top marginal rate on income was 70 percent. Though he most likely was in a lower bracket (even with a JD and MBA from Harvard), anything he made over $50,000 (in today’s dollars) would have been taxed at 25 percent or more. Plus he would have paid payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es of about 12 percent. Plus he would have paid Massachusetts income tax of about 5 percent.
Adding these up, Romney got to keep just over half his income in 1977. Over the years this would have changed somewhat, as the income tax rate in the 1980s came down and the payroll tax went up, but overall he would have paid a lot of taxes on these wages. Anything he saved and invested was then later taxed again, i.e. double-taxed, in the form of capital gains, dividends, and interest income. If he invested in corporate equities he was triple-taxed through the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , which ranged from 35 to 48 percent at the federal level over this period. If he chooses to pass his investments on to his heirs he’ll be quadruple-taxed through the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. .
If instead, Romney had consumed all of his wages he would have experienced a much lower tax rate, since there is no sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. at the federal level and sales taxes at the state and local level are generally less than 10 percent. This is why, in part, economists argue there should be low or zero taxes on investment income.
Now, Romney’s case is complicated by the fact that some of his investment income today is in the form of “carried interest” gains from his ownership of Bain Capital, which he started in the mid-1980s. Carried interest is in the grey area between wages and investment income, and it is not clear how Romney’s carried interest today should be taxed. Nevertheless, the general principle holds that just because investment takes a long time to provide benefits, it should not be overly taxed relative to immediate consumption.
Update: Here are some reasons to be cautious about upending carried interest contracts.
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