Income Tax Rates

Presidential contender Mitt Romney has shown and will release his income tax return for 2010. His income was $21.6 million and his federal income tax bill was 13.9% of that. More than half of his income was from capital gains and dividends, which are taxed at a top rate of 15%, rather than the 35% top rate for ordinary income (link). The tax rate on capital gains and dividends are not affected by the alternative minimum tax when it applies.

Do you think the different tax rates are fair? Assume two people, W and C, have $20,000,000 in income. W's is all from wages. C's is all from qualified dividends and long term capital gains. For simplicity assume no deductions except the standard one . W's tax is almost $7 million (35% x $20,000,000) while C's is almost $3 million (15% x $20,000,000). If a third person had income of $20,000,000 evenly split between wages and capital gains and/or dividends, the tax is almost $5 million (15% x $10,000,000 plus 35% x $10,000,000).

What justifies C's tax advantage? What would be unfair about higher taxes on C, especially if ordinary income tax rates for everybody were reduced so as not to increase overall tax collections?

The article linked above also addresses "carried interest", which is also income treated like capital gains and thus gets the lower 15% tax rate. It pertains mostly to hedge fund managers. A typical hedge fund charges its customers/clients 2% of assets plus 20% of gains per year. For example, if the fund has a 12% gain, the hedge fund collects 2% + .20 x 12%, or 4.4%. Ironically, if all this is paid to the manager, the first 2% is treated as ordinary income, but the extra 2.4% is treated as a capital gain (link).

So the manager gets the lower capital gains tax rate based on investing other people's money. An ordinary mutual fund manager does not, since his/her compensation for fund management is treated as ordinary income. This is also inconsistent with the tax treatment of stock options that employers grant to employees. If an employee receives such stock options and then exercises them, any gain is treated as ordinary income. (If the employee bought shares in the employer's stock on his/her own, any long-term gain would be taxed at the capital gains tax rate.)

Post 1

Tuesday, January 24, 2012 - 9:43am

The assumption is that a person had to initially earn the money that was invested to make the capital gains. Thus the capital gains is the second tax on that money. After awhile, the capital gains profits can be reinvested, and that would be, in a fashion, the third time the money was taxed.

All of the multiple taxation is annoying. Dividends are another example of money taxed twice. The corporation pays taxes on income, then some of that money goes out as a return to the stockholder (who had to earn, and pay taxes, on the money used to buy the stock) and is taxed as his income.

The state of Arizona, and probably all other states, tax me each and every year on my car. They have a property tax that hits me on my house - the same house that they have been taxing for every year I've lived here.

Looking for fairness in tax law is like looking for a good snow storm in hell.

Post 2

Tuesday, January 24, 2012 - 10:26am

Steve, thanks for mentioning the double taxation of dividends. One argument against raising capital gains tax rates is that doing so would depress stock prices. Making dividends tax-deductible to the paying corporation at the same time would likely pretty much offset that.

The assumption is that a person had to initially earn the money that was invested to make the capital gains.

Maybe and maybe not. Much wealth is inherited. In the case of hedge fund managers, it is the customer/client who (may have) earned the money, not the hedge fund manager.

Post 3

Tuesday, January 24, 2012 - 12:40pm

Merlin,

I thought about the issue of inheritance, but didn't mention it because the money still might have been earned by the person who left it to his heirs - and paid ordinary income tax rates on that; and there may or may not have been an inheritance tax on that money that had already been taxed and then would generate the capital gains that would be taxed yet again.

I hadn't thought about hedge fund managers.

People talk about a progressive tax rate... well, even a flat tax rate is progressive. A person who is taxed, say, 15% of their income will pay more in absolute terms if they make $1,000,000 per year than the person who pays the same 15% but only makes $10,000.

If we consider that we should only be paying for the proper services of government, which includes only the following: protection of our property, protection of our liberty, and protection of our person. (Actually we are paying for the structure and activities that maintain the environment most conducive to individual rights). Looked at that way, maybe we should pay more if we have more stuff to protect - like insurance policies go up in price as the value of the policy goes up. But the protection of liberty and of person shouldn't cost out very differently, theoretically, for a poor person versus a rich person. They both live under the same safety umbrella of the military defense forces and so on.

Anyway, I don't think there is such a thing as a really fair tax, because I believe it is possible to have a government that does what it is supposed to yet is fully funded with voluntary fees. But that is academic in terms of what should we like to see put forth in the next few years. In those terms, I would like to see...

flat tax rates instead of progressive tax rates,
decreasing the tax rates year after year as spending is cut,
eliminating the confusing complex of deductions and simplifying in the direction of a few, universal deductions and phasing them out year by year, and
shifting from taxation of investment and savings to taxing of consumption and the use of fees, and
shifting from hidden forms of taxation to highly visible - in your face - forms of taxation, and
until we can get rid of taxes, they should be for everyone - no free riders.

We are competing in a global market and that will just intensify with increases in technology and because of that it is crazy to tax businesses. They only pass the cost of taxation on to their customers, but in the mean time they are made less competitive than the same business in a country that taxes less. Capital is international and will travel at the speed of electronic transfer, and will chose the domicile that gives the best combination of safety and freedom from taxation. If we provide zero taxes on capital gains, dividends, and interest income then the flood of money coming our way would be like a giant, green tsunami. Our financial markets would be flooded! Take away taxes on businesses, and the growth in business activity in our country would explode.

Post 4

Tuesday, January 24, 2012 - 4:56pm

You took the words out of my mouth steve.
Case in point on corporate taxes the premier of alberta a few years ago decided to not only increase corporate taxes but also increase the amount oil companies pay on oil royalties.
Over night the corporations packed their bags and set up elsewere and many projects were mothballled.
He quickly said to himself.."wooops" and reversed many of his progressive ideas..the dumbass.

Post 5

Wednesday, January 25, 2012 - 5:02pm

I couldn't bear to watch BO's State of the Union speech, but I gleaned some of it�on the tv news or internet.�It sounded�more like a campaign speech than a report on the state of the�union. Of course,�the�demagogue tried to�gain support for raising taxes on millionaires.

However, what impact could it have on the big picture? Shouldn't a state of the union speech be about such matters? This Heritage Foundation article says the capital gains tax going to 20% again (already set to happen in 2013), according�to the Obama�Administration's own�estimates, would increase revenue by $105.4 billion over 10 years. That's an average of�$0.01 trillion per year versus a $1 trillion deficit and spending of about $3.7 trillion! Even the 10 year number is $0.1 trillion versus the federal government's debt of $16.7 trillion!

Obama wants more�like a 30% rate, which might raise tax revenues a bit more. Regardless, the effect on the big financial picture�would still be�tiny.

(Edited by Merlin Jetton on 1/26, 8:00am)

Post 6

Wednesday, January 25, 2012 - 5:10pm

Alls that will accomplish will be to force those same corporations to pack up and re locate to a place overseas with a far more company friendly tax structure and will result in an overall net loss of revenues.
In essence he will be pushing the accelerator to the floor of that bus heading over the cliff...

Post 7

Sunday, January 29, 2012 - 5:26am

Two things I omitted saying earlier about taxing capital gains:
1. If they were taxed as ordinary income, the cost basis should be adjusted for inflation.
2. If an appreciated stock is given to a charity, the donor should pay tax on the appreciation when the gift is made.

Post 8

Sunday, January 29, 2012 - 10:40am

Steve:

Most flat tax plans have a fixed exemption and a single rate above that exemption.

Example:

0-20000 is taxed at 0%, then everything above 20000 is taxed at a single rate.

This is truly a 'progressive' tax, both in terms of effective % and actual $.

It is also a 'flat tax.'   Everyone gets the same 20000 exemption. Everyone pays the same marginal rate above that exemption. But clearly, the more you earn, the more $ you pay, and the more % you pay in effective tax rate, as your effective tax rate approaches the marginal tax rate.

The only counter argument to this is that it isn't 'progressive enough,' and that is exactly where everyone's bullshit alarm should go off.

Progressive 'enough?'   As in, the Emperors of Enough declare so?   If you sound the left wing oceans of argument for 'progressive enough' what you will find is that they are as dry as deserts.   There is no 'there' there. There is only naked assertions.

The problem with that(or any)form of taxation is that it is still abusable politically; there is nothing inherent in even that model of flat tax that gets us out of the insane tribal nuthouse.   As in, Huey Long's version of a 'flat tax.'

0-100000, 0% tax.
100000+ = 100% tax.   As if.

Even my form of a 'flat tax above exemption' does not avert the tribal nut war.   It just shifts the divide and conquer and glom onto power by getting 51% of the tribe to go for it battleground to where is the exemption and what is the marginal rate.   The fundamental issue is the tribal nut war.

I'm starting to believe that the only way to solve this tribal nut war is to let the 51% live with the consequences of what they advocate and tolerate until even they get it, but I think that inevitability has long already started, and what we are seeing is the early signs of disbelief and denial and clinging to the old formulas.

regards,
Fred

(Edited by Fred Bartlett on 1/29, 10:42am)

Post 9

Sunday, January 29, 2012 - 10:54am

1] Always eat the top 1%. After all, it's just 1%, and they are doing fine relative to the 99%.
2] Lather, rinse, repeat. Proceed to step 1...until the inevitable terminus:

... two pathetic souls in a hovel, showing each other their sores, arguing over who most deserves the last not so maggoty piece of rotted meat.

This is what American politics has degraded to, and this is what American politics will lead us to, if it is not turned around.

The arguments against are based on the following myth: American capitalism left a big carcass, and there is still a lot of meat to pick over on the carcass, even as the bones are showing.

Not a great plan. Not even a good plan. But a politically viable plan.

Post 10

Sunday, January 29, 2012 - 12:06pm