Romney and His Taxes

This is a quiet day.

Except for Mitt Romney and his charge to the Republican nomination. A furor has broken out over Romney’s tax rate. He, like many very wealthy Americans, lives in a different tax code from the rest of us. Up there in the higher reaches of the income atmosphere tax rates are lower than they are down here on planet earth. Clodden folk pay higher marginal rates than the high flyers. We have known this for a while. So the outbreak over Romney’s tax returns is a brouhaha long in the making.

The facts are simple.

The US taxes income generated by labor at a variety of tax rates rising to a top rate of 35%. This top rate kicks at about $380,000. Allowing for the variety of deductions, credits, and other dodges, the average middle income tax payer ends up paying around 20% on their total wage bill. Remember this is Federal tax only. States and cities levy taxes on top of this.

Obviously Romney earns way beyond that $380,000 level. Yet his average tax rate is close to 15%.

How come?

His income consists largely of dividends, capital gains, and other “unearned” income. The top rate, at the moment, on these sources of income is 15%.

Why?

Because the source of that income has already paid tax on it in the form of corporate taxes, and so it is ‘unfair’ – so some people argue – to impose income taxes on that stream of cash twice. This so-called double taxation problem is at the heart of Republican arguments to abolish taxes on such gains in their entirety.

But this is a recent argument. Capital gains were taxed at much higher rates in the past without, apparently, dampening the flow of capital so any argument suggesting that high taxes on these sources of income are a disincentive defies history. They weren’t.

More importantly, though, is the hidden story. As we all know: most corporations do not pay taxes. They are able to exploit the convolutions of the tax code to reduce their liability to zero. So the cash stream that ends up as dividends is largely untaxed. So non-wage income is vastly privileged, and flows with much less of a burden. It is just one aspect of the three decade long development of our rentier style economy within which wages are squeezed while profits soar and feed into the cash flow that ends up in the hands of people like Romney. The gradual disappearance of corporate taxes as actual rather than theoretical payments invalidates the double taxation argument.

But it’s worse.

One of the most egregious tax dodges still on the books is the notion of ‘carried interest’. This is the outrage that allows hedge fund managers earning hundreds of millions a year to pay at the lower capital gains tax rate rather than at the higher income tax rates. Carried interest is a performance fee levied by money manages on the funds they manage. It is calculated as a percentage of profit after having paid back the original capital that investors invested, and any agreed target rate of return. The residual net cash flow is then either distributed back to investors or paid out to the fund managers as carried interest. So the cash flowing into the carried interest bucket is simply a fee carved out from the revenues of the business. There are plenty of businesses that pay their managers incomes from the residual cash flows. Usually they are accounted for as partnership income, salaries, or bonuses. But not in the shady world of high finance. Somewhere along the line the finance industry managed to re-name these payments as carried interest and get them taxed as capital gains.

Technically the source of the income is the gain on the capital invested. But – and this is the crucial point to keep in mind – it isn’t the capital of the fund managers. It is the capital of other people, the investors in the fund.

In other words, private equity and hedge fund managers are being paid fees – taxable as income under normal circumstances – and, by sleight of hand, counting it as capital gains – taxable at the lower rate. It isn’t their capital. It is one thing to support capital gains tax as appropriate on gains from capital; it is another to tax ordinary fee income as if it were a gain on capital. It is no such thing. It is an outright cheat.

Back to Romney: in his days at Bain he earned huge fees as a private equity fund manager, re-named those fees carried interest and thus reduced his tax bracket substantially below that of any regular person. Like the ones he was firing in order to create those capital gains for himself. He was not alone of course. The entire hedge and private equity fund industry pulled the same scam.

So.

Not only is Romney paying a lower rate on his current income – because it comes, predominantly, from dividend and capital gains, but he was part of the big carried interest swindle perpetrated on the regular taxpayers by the finance industry. Romney lives in that rarified 1% world were the rules are specially designed to keep the wealthy secure from the problems of the rest of us face routinely. It is no surprise to find that, over the past three decades, the high end business managers and financiers responsible for managing our economy have down so to their own advantage. The epic shift in wealth to the top tier is well documented. That they distorted the tax code along the way to keep more of the loot is less well known. It ought to be. Especially in these more straitened times when the management of that top tier has been exposed as a dismal failure. They steered the ship onto the rocks and made off with the money. They are bankrupt of ideas, but well-heeled in wealth. They in ovulated themselves ahead of their failure so as not to be harmed by it.

Romney is one of them.

As his tax returns, when and if we see them, will attest.

Whether people care is another question.