Are Capital Gains Taxed Twice?

NPR has taken some criticism on its coverage of former Governor Romney’s taxes. , an ombudsman for NPR, has an excellent, balanced response to the criticism. In some places he agrees with the criticism and in other areas he provides more analysis which informs the dialog. Specifically he provides a more in-depth analysis of the double taxation issue. That is the notion there’s a double tax — Governor  Romney pays 15% federal capital gains tax which has already been taxed at the corporate level at 35%. Critics say this amounts to double taxation.

Previously, I have posted studies demonstrating that the corporate effective tax rate is not close to the mentioned 35% statutory rate. I won’t repeat the results of those posts except to note you can find the information here, here, and here.

The contribution of NPR’s ombudsman is his elaboration of issues associated with double taxation. Schumacher-Matos analysis follows:

“The second issue has to do with the concept of double taxation itself — a concept that is highly disputed. For example, almost all of us who earn salaries are hit by double taxation. Our employers match our payroll taxes. Most economists agree that this “employer half” is effectively subtracted by companies from the wages they pay us, in effectively the same way that corporate taxes are subtracted from the profits distributed to investors. Additionally, it is not clear that corporate tax costs are passed on to investors anyway, and might instead be paid by employees (through reduced wages) and by consumers (through higher prices).

This debate over corporate tax “incidence” has divided economists for years and will surely do so for years more. This suggests that there is nothing conceptually special, galling or even agreed-upon about double taxation paid by corporate investors.

Almost all of Romney’s investments in companies, moreover, were not directly in the companies themselves but in funds. It is the funds that are the direct investors in the companies. A “pass-through” concept links the fund investors and the companies, but this concept becomes ever more tenuous in the modern financial world of hedge funds and derivatives.

In Romney’s particular tax case, there is more still to consider. Much more. Until now, we have been exploring the quarter of his income that is indisputably capital gains. Another nearly 30 percent of his income—$7.4 million—was in so-called “carried interest,” according to Romney campaign chief counsel Benjamin Ginsberg in a conference call with reporters. Carried interest is taxed like a capital gain but is a very different type of income altogether. It has almost no ties to corporate profits and thus is not subject to a double-taxation claim.

Almost all this income continues to come from Romney’s past interest in Bain Capital, a private equity firm he founded. Carried interest is considered by many economists to be conceptually more like a commission because it is earned by private equity managers from the investments made by their firm even if they don’t invest their own money. Additionally, a core strategy of private equity firms is to borrow against the target company in which they are investing precisely so that the interest on the loans reduces corporate taxes to as low as zero. Perversely, in other words, instead of there being a double taxation claim, it can be argued that firms such as Bain borrow, take risks and grow at the expense of other taxpayers.

None of this is secret. Congress repeatedly has made a value judgment in devising the tax structure and rates that have benefited Romney. Congress—both parties, at different times—voted to benefit investors and financiers with lower tax rates for investments than those paid on wages on the grounds that this would help stimulate more investment and, in turn, the economy.

Romney benefited from a host of other deductions, such as for charitable giving, and legal maneuvers, such as in the establishing of trusts and offshore investments. Because of these deductions, his total real income was surely much more than the reported $21.7 million in “adjusted gross income.”

You must decide for yourself whether you agree with the policy rationale for taxation on business investments and if it should apply in all the ways it does now. President Barack Obama and many Democrats have proposed reversing the benefit for carried interest. Newt Gingrich goes in the other direction and proposes doing away with the capital gains tax. Romney himself has proposed keeping it at current levels for high earners, but eliminating taxes on dividends and capital gains for households that earn less than $200,00 a year.

Capital gains tax is long enshrined. Until 1921, the rate was equal to that on wages, according to Roberton Williams, senior fellow at the authoritative and non-partisan Tax Policy Center. The argument that a high capital gains tax was counter-productive prevailed after the war, and it was cut to as low as 13 percent, he said. Beginning with the Great Depression it mostly fluctuated, though during four years under Ronald Reagan in the 1980s, wages and capital gains were again taxed the same—28 percent. The current rate was passed by Congress in 2003.

This history suggests that the current rates and structures are not engraved in stone, or even proven in their effectiveness. Economists are divided on what is the optimal rate that encourages investments, jobs and economic growth, plus maximizes tax income.

Then there is the moral argument. If tax levels are not seen by most Americans as fair, they lose their legitimacy, which is an existential threat to the nation itself. A democracy is held together by more than its rules. People must believe in the tax structure, and its fairness for all.

Enter the so-called Buffett Rule proposed by President Obama. The rule would impose a minimum tax rate of 30 percent on the highest income earners in the United States, no matter how the money is earned. The rule is named after legendary Warren Buffett who has complained that he paid a lower tax rate than his secretary.

You will decide for yourself what is moral and fair, and what you think the collective ethos of the nation is. My concern and that of NPR is what is fair in the reporting on Romney and the broader tax issues. Should stories be framed in the context of progressive total tax payments, of economic stimulus, of double taxation, of finance loopholes, of the lesser value of work, of the historical fluctuations or the division among economists? All these questions reflect elements of truth and are legitimate.

But one thing is clear to me. To frame a news story or analysis only in the context of double taxation would be incomplete and misleading. The rate Romney paid is what it is. The justifications are a separate argument best left to a separate story that explores these many angles.”

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