The case against taxing Mitt

Mitt Romney pays little in taxes.

The Republican candidate’s 2010 income tax returns showed he paid just 13.9 percent of his annual income in taxes.

His low rate is due to the fact that much of his income takes the form of capital gains on investments, which are taxed at 15 percent instead of the 35 percent top marginal rate for wage earners.

Many people say it is unfair that a multimillionaire former CEO pays a tax rate in the teens while working Americans are saddled with higher rates.

These people are right, but for the wrong reasons.

A 15-percent tax on capital gains and interest income is too high. Romney’s tax rate on his capital gains on investments should be 0 percent.

Investment income should not be taxed because the money used to make the investment was already taxed as ordinary income when it was earned as wages.

Imagine two people trying to make it in America today: Sonya the spendthrift and Tom the tightwad. They both worked equally hard summer jobs that paid them both $4,000. They were both taxed (to make the math easy let’s say at 50 percent), leaving them with $2,000 to start the semester.

So far we have total equality.

At the start of the year, Sonya takes her entire paycheck from the summer and heads to Kirkwood Avenue, spending all her money partying until 3 a.m. at Kilroy’s. Tom, a business student, has aspirations of starting his own restaurant business after graduating, so he patiently forgoes $2 Tuesdays and invests the entire $2,000 so he can cover his startup costs.

When he graduates, his investments will earn him a nice return of 20 percent — $400
.
In essence, Tom is compensated for his decision to forgo $2,000 dollars of consumption today with $2,400 of potential consumption after he graduates.

Should Tom be taxed on his $400 capital gain? Of course not. In the situation, when there is no capital gain or interest tax, there is no unfairness because both Sonya and Tom were taxed the same amount on the same earnings before Tom chose to invest.

The only place they differed is in how they chose to enjoy the $2,000 they earned.

Presumably, they both used the $2,000 in the way that gave them the most satisfaction. Sonya preferred to spend it right away, and Tom was happy to save it until he graduated.

Introducing a capital gains tax is unfair to Tom the tightwad because he is taxed more for his choice to save.

Romney prefers to be like Tom the tightwad. Most of his capital gains income came from a blind trust Romney formed with his wife in 2003. This trust and another family trust are his main vehicles of saving for the future.

Because the returns of these trusts are taxed at 15 percent, Romney is essentially punished for forgoing consumption of his wealth when he earns it. He has already paid his fair share when he earned his ordinary income. Like Tom, he is taxed more if he chooses to save more, giving him incentive him to become more like Sonya the spendthrift.

Is that what we really want?

It’s fair to debate whether the wealthy should pay a higher tax rate, but it is not fair to demand that savers pay more tax than spenders.

With no capital gains tax, people like Romney would invest more of their earnings back into the economy, where they help businesses expand and spur economic growth.

­— bmritz@indiana.edu