Some conservatives insist the GOP frontrunner pays half his income to the government. Their math is wrong, but their point is right on: Double taxation is a problem.
When the media reported that Mitt Romney's total tax rate was 15%, some people were mad at Romney for taking advantage of the tax code. But others were mad at the media for getting it wrong.
Mitt Romney's tax rate was not 15%, this group said. It was more like 50% because Romney's income is doubled taxed. He derives the vast majority of his income from corporate investments, which are taxed first under the 35% corporate income tax rate and second under the 15% rate for capital gains.
"There are two levels of taxation in capital gains," Mitt Romney explained succinctly to Larry Kudlow on CNBC. "One at the corporate level, which is a 35% rate, and another at the individual level, which has been 15%. So combined it's about a 50% tax."
The IRS, corroborated by some smart people, says Mitt Romney's real tax rate is 15%. Yet Mitt Romney himself, corroborated by other smart people, claims his real tax rate is more like 50%.
THE MISERY AND THE MYSTERY DOUBLE TAXATION
To understand the Romney's argument you have to understand something called double taxation. The standard argument against double taxation goes like this. Let's say you all own stock in Derek, Inc, which earned $100 in 2011 (sorry, I'm not a very good company). I'm taxed at the corporate rate of 35%. Out of $65 that remains, I offer a dividend to all of you to thank you for investing in me. That dividend is taxed, again, at 15%. That is double taxation. It brings the total tax on your kind investment to a total of 44.75%. That sounds outrageously high.
But like Derek, Inc., this standard argument against double taxation is only theoretically plausible and mostly mythological. The vast majority of companies pay far less than 35% of their income in taxes. GE paid practically nothing in 2011. Google paid about 22%. Out of 280 companies in a study by Citizens for Tax Justice, more than 250 had a tax rate under 35%.
Another way to see why the toll of double taxation is often far less than 44.47%, ask yourself a simple question: Why would I buy a stock in a company? Maybe it's that the company is making money. But maybe it's also because the company has potential. "If an oil company discovers a huge new oil field, its value will increase substantially well before any additional oil is extracted from the ground and sold at a profit," the Tax Policy Center's Eric Toder explained. If you sell that oil company's stock right after it shoots up, much of your capital gain isn't double taxed because it represents the hope for future income.
Back to Romney. Private equity firms like Bain Capital buy, fix, and sell companies whose profit comes after restructuring. The money private equity firms get from selling winners reflect the market's expectation that the newly buffed companies will perform well in the future. That's one reason why "the tax burden on private equity partners [such as Romney] is a lot closer to 15 percent
than to the 44.8 percent figure," Toder says.
THE TAX CODE WE DESERVE
If I've convinced you that double taxation is no big deal, then ... I've failed. Double taxation does matter. But not for the reason that Romney is paying too much to Washington.