Why Doesn’t Mitt Romney Pay More in Income Taxes?

January 25, 2012

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English: Governor Mitt Romney of MA

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Mitt Romney has released income tax information, any many people are shocked that he paid an effective rate of just 13.9% in 2010.  His opponent, Newt Gingrich, pays an effective rate of 30%!  Is Romney doing something illegal?

The reason for Romney’s rate

The reason why Romney pays a far lower rate than Gingrich isn’t due to some strange loophole that Romney pays his lawyers to exploit.  It’s simply due to the fact that capital gains are treated differently than ordinary income.  While tax rates on ordinary income (wages, interest, etc) range from 5% to 35%, capital gains are taxed at 15% (although taxpayers in the 5% and 10% brackets pay their ordinary rate on capital gains).

This means that if I have a $1000 capital gain and Mitt Romney has a $1000 capital gain, we will both pay taxes of $150 on that income.

Mitt’s income is nearly all derived from investments.  He doesn’t have a wage-earning job.  While he does make a few bucks from book royalties, it pales in comparison to his investment earnings.  Throw in some deductible charitable contributions, and Romney is able to chisel the 15% rate down to 13.9% without much work.

Why are capital gains taxed at a lower rate?

The basic idea behind a lower rate for capital gains is that this will encourage people to invest in capital assets (ownership of companies) instead of keeping their money in a mattress or a passbook savings account.  There’s more risk in doing this, of course, so one way to balance the risk/reward is to allow profits to be taxed at a lower rate.

Is the capital gains rate too low?

In my opinion, yes.  It seems absurd that a $500 capital gain and a $5 million capital gain would be taxed at the same rate, when $500 or ordinary income and $5 million of ordinary income would be taxed at different rates.

Do I think that capital gains should be taxed at the same rate as ordinary income?  No.  I do believe that there’s is value in encouraging investors to put their money into equities.  It clearly is a riskier proposition, and I’m OK with a lower capital gains rate being a reward for taking that risk.

My suggestion would be to make the capital gains rate 2/3 of the rate for ordinary income.  Under this plan, the capital gains rate would be 7% for those in the 10% tax bracket and would top out at 23.45% for those in the 35% tax bracket.  Mitt Romney would still pay a lower effective rate that Newt Gingrich or Alex Rodriguez, but would pay far more than he does today.

What’s an effective rate?

As a last bit of explanation, let’s look at the difference between a marginal rate and effective rate.  You might be in the 25% tax bracket.  This doesn’t mean that you pay a 25% tax rate on all your earnings.  Tax rates on ordinary income are marginal.  If you are single and make $50,000 (this would be in the 25% bracket), you would pay 10% on the first $8500 of taxable income , 15% for the amount between $8500 and $34500, and 25% on the amount that exceeds $33950.  That would be a total tax of $8625 on $50,000 of taxable income – or 17.25%.

The second point is that there is a big difference between your gross earnings and taxable income.  You’ll reduce gross income by the exemptions for yourself, spouse, and children, and well as a variety of deductions (mortgage interest, property taxes, charitable contributions, etc), and credits (earned income credit, child tax credit, etc).

effective rate is often calculated against gross income (AGI), his effective rate drops to $12.5%.

A married couple with two dependent children who have an AGI of $50,000 and take only the standard deduction and personal exemptions (no itemized deductions or credits) will pay $2690 in federal taxes … an effective rate of 5.4%.  This is achieved by excluding a total of $26400 via the $11,600 standard deduction for married filing jointly and $14,800 in personal exemptions (four exemptions @ $3700 each), dropping the couple’s taxable income down to $23,600.

 

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6 Comments (+add yours?)

  1. Martin Kelly
    Jan 25, 2012 @ 13:54:29

    Kosmo, nice analysis. Just for grins I looked at my effective tax rate. I have ranged from 4.9% in 2002 (Bush tax cuts) to 9.3% in 2008 averageing 7.6% over the last 20 years. If people look at their own effective rate, I don’t think this will be much of a motivator to not vote for Romney.

    On another note, I noticed you stated “Throw in some deductible charitable contributions” and from the report I saw his charitable deductions were almost 15% of his income. Personally, I think I have maxed out at about 2% charitiable giving.

    I disagree with your conclusions in some ways. Although I agree that the reduced capital gains is for some people an encouragement, but I think that the main driver for capital investment is that gamble that it will pay off at a terrific profit. I truly believe that a flat tax for EVERONE for every dollar earned regardless of source would be the most equitable. If someone is financially in need, then address that with governement aid, then we can close off the political retoric of “tax the rich” especially since we are approaching half of the population not paying any income tax at all.

    Reply

  2. kosmo
    Jan 25, 2012 @ 14:07:09

    You’ve read the article I wrote in response to that “half the population doesn’t pay taxes” thought, right? While certainly the number is a significant number, it’s considerably less than half.
    http://www.thesoapboxers.com/how-many-americans-dont-pay-taxes/

    We’d need a flat tax of about 11.5% to generate the same amount of revenue as the existing tax code. That means raising taxes on ~85% of taxpayers.

    Whether or not this would be fair is irrelevant. It would be political suicide to enact such legislation. The 85% of taxpayers who would see their taxes raise also have the ability to cast 85% of votes.

    There’s lots of interesting discussion point about a flat tax, but in the end, I think it’s much ado about nothing because no congress will ever pass such legislation.

    Reply

  3. Martin Kelly
    Jan 27, 2012 @ 08:17:54

    Kos, I agree that no cogress would have to courage to actually implement this plan. I resently saw the movie “The Iron Lady” about Margaret Thatcher. She did just what we are discussing. As she pointed out, graffiti and other destruction of public property is at least partly based on the fact that a lot of people don’t care since it will cost them nothing. She implemented a tax on lower income people and the cost of governement went down!

    Just a pipe dream for me. I would pay more in taxes, both real dollars and percentage but it would be a better, simpler system. I thought that the break even number was closer to 15%, but I have not researched it.

    Reply

  4. kosmo
    Jan 27, 2012 @ 08:47:28

    I’m guessing the 15% is what would be needed for a balanced budget? 11.5% is what would be needed to match current income tax revenues, since this is the overall rate according to IRS data.

    Knowing you personally, I do believe that you’d be OK with paying more in taxes. But you’re one voter. Let’s take that hypothetical family of four making $50,000. Their effective rate would go from 5.4% to 15% under your plan.

    You just increased their taxes by $4800. How many of these people are going to be happy about that?

    The core math issue is that Romney makes as much as 400 families with an income of 50K/yr. You can increase Romney’s rate by 1% and increase revenue by as much as you do by raising the rate of these 400 families by 1%. But if Romney (or someone else making 20M) is upset, his household has two voters. If the 400 families are upset, they have 800 voters.

    So do you anger the small group or the large group? That’s the political question.

    Reply

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