I have a tendency to avoid watching presidential debates, primarily because I'm convinced that the best debater does not necessarily make the best president. Of course, debates can be quite entertaining; however, they tell us more about how well a candidate can think on his feet than they do about what he really stands for. In addition, one mistake in a debate could kill an entire campaign. Witness Rick Perry's inability to recall one of three departments he would shut down if elected president.
Nonetheless, the topic du jour is Mitt and Ann Romney's taxes. It has become a big issue, largely due to Mitt Romney's unwillingness to release information about his tax returns earlier in the campaign, as well as his inability to properly defend what he actually pays in taxes.
So instead of relying on what is being reported in the media, I decided to take a look at the Romney's just-released tax returns. In 2010, Mitt and Ann Romney reported interest income of $3,295,727. Interestingly, only $557 of that amount was non-taxable. Obviously, they are not big buyers of municipal bonds. The Romneys also reported $4,923,348 in dividend income. Of this amount, $3,327,678 were considered qualified dividends, meaning they were taxed at the lowest rate of 15%.
The Romneys also had quite a lot of capital gains, in fact $12,573,249 worth. Most of the capital gains were of the long-term variety, which means they, too, were taxed at the lowest rate of 15%. Making some relatively minor adjustments, the Romney's total adjusted gross income for 2010 was $21,646,507. That's certainly a lot of dough by almost anyone's standards.
It turns out the Romneys are also very charitable people. In fact, they donated $2,983,974 to charity in 2010. Their total allowable itemized deductions came out to $4,519,140. Including their exemptions, their taxable income was $17,120,067. Their total tax bill (which includes the alternative minimum tax, self-employment tax, tax on IRA or 401(k) income, and a credit for foreign taxes paid) came out to $3,009,766. In other words, their tax rate was 17.6% of their taxable income. This is higher than the 14% tax rate widely reported in the media. The difference is explained by the fact that the media is calculating the tax rate on adjusted gross income rather than the tax rate on taxable income. But the media's calculation is misleading because it ignores things such as charitable contributions.
The Romneys also released projections of their tax return for 2011. Even though they increased their charitable contributions, their tax rate on taxable income is actually expected to rise to 21.2% for 2011, quite a bit higher than it was in 2010.
Here are two points that Mitt Romney needs to articulate better: 1) One reason the Romneys' tax rate appears low (as a percentage of adjusted gross income) is because they have been extremely charitable. If the Romneys had not donated so much money to charity, their tax rate would be substantially higher. 2) A second reason their tax rate appears low is because the vast majority of their income is in the form of qualified dividends and capital gains.
Some will argue that it isn't fair to tax capital gains and qualified dividends at a lower rate than ordinary income. I would argue that it isn't fair to tax this kind of income at all. Why? Because it has already been taxed at the corporate level. Taxing corporations is exactly the same thing as taxing shareholders directly. When corporations pay taxes, there is less money left over for the shareholders.
When a corporation hires an employee, that employee's salary is a tax-deductible expense for the corporation. As a result, it is perfectly fair to tax that employee's wages at the ordinary rate. However, when a corporation pays dividends, that money comes from after-tax earnings. When the stock price rises creating capital gains, those gains represent the after-tax performance of the corporation. If corporations were not taxed at all, the sum of the dividends and capital gains would be much larger than they are now. In that case, it would be perfectly fair to tax dividends and capital gains at the ordinary rate.
As things currently stand, the effective tax rate on dividends and capital gains is actually much higher than the effective tax rate on ordinary income. This is because the effective tax rate is actually equal to the tax rate that corporations pay plus the tax rate that individuals pay on dividends and capital gains, a figure that is closer to 50%, and much higher when state taxes are taken into account.
I have long been an advocate for a simplified tax code. Our current tax code has become so convoluted and confusing that only expert accountants can make heads or tails out of it. Furthermore, our current code fools large numbers of people into believing that the rich pay less taxes than the poor. In my perfect world, I would eliminate the tax on corporations (which would also eliminate the incentive that corporations currently have to finance themselves with tax-deductible debt). I would also eliminate ALL tax deductions (including those for mortgage interest and charitable contributions). Finally, I would introduce one low flat tax rate on all income. Although I would hate to do it, I would even be willing to go along with mildly progressive tax rates. All of this could be done in a revenue neutral manner. Yet I wouldn't hold my breath. With so many groups lobbying Congress for one exception or another, I don't really expect any of this to become reality. On the contrary, if I had to bet money, I would bet that the tax code will only get more and more convoluted as time goes on.