How many times should your money be taxed? One time? Two times? Three times? Four? Sounds like a ridiculous proposition, but that’s the true story of capital gains taxes in America, and it’s one that’s not being told in the continuing debate over Governor Mitt Romney’s taxes.
For more than a week, the media has focused on the subject of just how much Romney pays in taxes. On Tuesday, the governor released his tax returns indicating that he paid about 15 percent in taxes last year. At first blush, that sounds like a low rate, especially considering that Romney is admittedly worth millions. But as with all things in politics, there is more to the story.
As most Americans know, marginal individual income tax rates in America range between 15 and 35 percent. However, Americans making money from investments typically earn dividends. They face a lower rate to reduce the tax barrier to investing and growing businesses. For Americans in the lowest two income brackets, the tax rate on dividends is zero. For all the rest, the dividend tax rate is 15 percent — hence Romney’s rate.
Why do dividends face lower rates than wages or interest income? Because dividends have already faced one full level of tax at the corporate level.
But that’s income tax. Americans making money from investments also typically pay a capital gains tax at the same lower rate as for dividends. Income and capital gains are very different. Income is what is generated from using resources, as wage income is generated by providing labor services, whereas a capital gain results from an increase in an asset price. Capital gains face a lower rate to reduce the tax barrier to investing, especially in high-risk, high-return, job-creating, business-growing investments.
So right off the bat, Romney is paying what is legally required of him — and even when compared to the average federal income tax burden in America of 9.3 percent, he’s paying more. There’s still more to the story, though.
When Romney pays 15 percent to Uncle Sam, that’s not the first time that money was taxed. J.D. Foster, the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at The Heritage Foundation, explains that Romney’s money has likely gone through four levels of taxation, meaning that the level of taxation was at 50 percent and likely much higher:
At the very least, he paid nearly 45 percent, but a chunk of this tax was collected before he even saw the remainder. Income from capital gains and dividends means the income was first earned by businesses, most likely corporations which paid tax at 35 percent. So Romney paid his 15 percent only after the government had taken its 35 percent cut. That leaves Romney with a combined tax of 45 cents on the dollar of corporate earnings.
So that’s two levels of taxation — the corporate rate and the capital gains rate. But there’s more. Foster explains that Romney’s cash was likely subject to taxes on capital income repeatedly in the past. Few investments are one and done; rather, most are earned taxed dividends and capital gains over extended periods that are reinvested and taxed again and again. This is a third “level” of taxation. And then Romney was also taxed at the individual rate as wage or salary income–a fourth level. And that’s how you get above 50 percent in taxes. (And don’t forget that Romney contributes 15 percent of his income to charity–money that might not be available if the capital gains tax were raised as many liberals propose.)
Are four levels of taxation, topping out at 50 percent “fair” enough for the left? Unfortunately, the truth about capital gains taxes don’t fit as neatly into a headline as ‘Millionaire Only Pays 15% Tax Rate,’ but Americans deserve to know the truth — and they also deserve to be able to save, invest, spend, and contribute the money they have earned without it being confiscated by progressive politicians seeking a “fair” redistribution of wealth ushered in by a growing federal government.
Instead of eating the rich and burning down their mansions, Congress should find ways to make it easier for Americans to keep their money, invest it, and become more prosperous. In a new paper, Heritage’s Curtis Dubay enumerates ways that Washington can focus on growth and set the economy free, among them: prevent tax hikes, extend the payroll tax holiday or replace it with a more pro-growth policy, make permanent the tax cuts that expire at the end of the year, avoid raising taxes after cutting taxes, repeal the Patient Protection and Affordable Care Act and the tax hikes that go with it, and switch to the New Flat Tax, which would tax individuals on what they spend each year rather than what they earn.
In politics, it’s easy to demonize the rich and engage in class warfare, but tearing people down instead of building others up is no way to govern a country. If Washington politicians truly want to turn America around, they should focus on ways to raise the bar and help individuals succeed–not knock down real success stories in order to become populist heroes.