Mitt Romney has told reporters that he pays an effective tax rate of roughly 15 percent on his income. Newt Gingrich, wealthy but not in the same league as Romney, has released tax returns that indicate he paid an effective rate of 32 percent, more than twice as high as Romney’s rate.
How is that possible? Well, we still don’t have Romney’s tax returns, so all we can do is make highly educated guesses at this point. Romney tells us that “my income comes overwhelmingly from some investments made in the past,” and under federal law those dividends and capital gains are taxed at only 15 percent.
In Romney and Gingrich, then, we’ve got useful examples of two types of taxpayers: those who receive most of their income through investments, what used to be called unearned income; and those who receive most of their income through actual work, such as serving as historian to Fannie Mae. Those who earn their money directly pay much higher taxes than those who receive it through investments.
In effect, a household making $100,000 a year by getting up in the morning and going to work is going to pay roughly twice as much in taxes as a household next door with an identical income derived entirely from investments. In terms of simple fairness, I think most people would have problems with that kind of arrangement. So if you’re going to tax labor at twice the rate that you tax capital, you better have a very good public-policy reason to do so.
In general, two such reasons are offered:
1. Theoretically, by lowering taxes on dividends and capital gains, you encourage savings and investment, which is good for the economy. In practice, however, there’s no evidence that cutting taxes on investments actually works that way. In fact, a 2010 study by the nonpartisan Congressional Research Service that looked at the history of investment taxes concluded that the opposite is true:
“Capital gains tax rate reductions appear to decrease public saving and may have little or no effect on private saving. Consequently, capital gains tax reductions likely have a negative overall impact on national saving. … capital gains tax rate reductions are unlikely to have much effect on the long-term level of output or the path to the long-run level of output (i.e., economic growth).”
In other words, cutting the capital gains tax has shown no demonstrated impact on the level of private savings and investment, but it does increase the federal deficit by decreasing tax revenue. Overall, it lowers aggregate national savings and does nothing for the economy.
2.) Taxes on dividends and capital gains should be lowered or even eliminated because they amount to double taxation. The argument is that corporate profit is taxed once when it is earned by the corporation, and taxed again when that profit is returned to the investor in the forms of a dividend or capital gain. So of course that second level of taxation should be reduced.
That’s a legitimate point, to a degree. Its validity depends on whether that corporate income tax is actually paid in the first place, which is questionable in many cases. In fact, this little nugget from a column in today’s New York Times illuminates the issue perfectly.
Floyd Norris writes:
The most interesting effort to end double taxation of dividends came from President George W. Bush in 2003. He proposed that dividend payments be tax-free — but only if the company could show that the dividends were being paid out of profits on which federal income taxes had in fact been paid.
That proposal caused something close to panic among some business lobbyists. Had it been carried out effectively — and it was evident that the Bush administration had not thought through all the details before announcing the proposal — the result would have been that companies that pay taxes would have been able to offer tax-advantaged payouts, while those that managed to lobby for loopholes would have had to tell shareholders that they could get no such tax break. Shares in taxpaying companies would have outperformed shares in others, at least until a new equilibrium was reached.
The Bush proposal quickly was changed to simply lower the rate on dividends to 15 percent, the same as the new capital gains rate. Before that, the maximum tax on dividends had been nearly 40 percent, while the capital gains rate went as high as 21.2 percent. Share owners get a break whether or not the profits being paid out were actually taxed at the corporate level.
In other words, when offered the chance to eliminate double taxation of corporate profits as long as the corporate taxes were paid, the business community refused. Much as they complain about it, they like the current system just fine, thank you very much.
– Jay Bookman