It’s real simple: If you think the biggest problem facing the United States today is income inequality, then you should be outraged that Mitt Romney’s income tax rate isn’t higher. But if you instead think America’s biggest problem is high unemployment and a lack of economic growth, then you should be outraged that Romney is paying any income taxes at all. Really.
See, most of Romney’s income is capital income—income from investments. And in the United States, capital gains generally are taxed at 15 percent vs. a top marginal income tax rate of 35 percent on ordinary wages for those making around $400,000 a year or more. But even folks with taxable income as low as $35,000 in 2011 will pay a much higher marginal rate, 25 percent.
Now, apparently that simple fact set is supposed to drive average Americans to a) seek out and join the nearest Occupy protest, b) support President Barack Obama’s “Buffett Rule,” so millionaires pay at least the same tax rate as middle-income households, and c) reelect Obama. At least, that’s how the liberal commentariat is playing it. Time for a reality check:
1. While Romney’s tax rate is—in his own words—”probably closer to 15 percent than anything,” that’s still higher than the 8.2 percent average
total effective income tax rate (as of 2010) of U.S. households (once you factor in various tax credits). Indeed, nearly half of U.S. households pay no income tax at all. Their average effective tax rate is actually negative. Even if you add in the payroll tax, the effective tax rate of the middle fifth of U.S. taxpayers is 12.8 percent.
2. The 15 percent headline rate is just the start. The capital gains tax is a double tax. For instance, corporate profits are taxed first as income and then a second time when they are distributed to shareholders as dividends. And capital gains from investments are not inflation adjusted, so taxes are often paid on illusory profits.
3. We shouldn’t tax what we want more of. And the real problem with the capital gains tax isn’t the rate or how it is structured, but what is taxed: gains on investments, which are savings put to work. Economists of all stripes have been saying Americans have consumed too much and invested too little over the past decade. So why would we want to tax investment even heavier, as the Obamacrats want to do?
Indeed, we shouldn’t want to tax capital at all. As an AEI study on consumption taxes explains: “The income tax’s penalty on saving is an undesirable distortion of consumer choice. It also causes less capital to be accumulated in the United States. The reduction in capital accumulation reduces labor productivity and lowers real wages throughout the economy, depressing the standard of living of future generations. Some studies have found that a switch to consumption taxation would increase the size of the U.S. economy by as much as 9 percent in the long run, although other studies estimate smaller gains.”
4. So the main reason people want to keep taxing capital—or even tax it more heavily—is one of theology rather than sound economics. As the Concise Encyclopedia of Economics puts it: “Strange as it may sound, most economists would agree that having zero taxes on capital income is theoretically the best thing to do. But many reject putting this theory into practice because they think that too much of the benefit would go to the ‘wrong’ people, namely high-income households and the wealthy.” That’s right, the desire to make sure the wealthy like Romney “pay their fair share” is desired by class warriors even if it make everyone poorer than they otherwise would be.
5. Take it away, JFK ( in his Special Message to the Congress on Tax Reduction and Reform from Jan. 24, 1963): ”The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential growth of the economy.”
Bottom line: Americans should pay taxes on their wages only, not on any income from saving. The right capital gains tax rate is zero, for everybody. Might a few rich people like Romney pay less in taxes? Maybe. But the result would be a stronger economy, more jobs, and higher incomes for all Americans.
UPDATE: I almost forgot a new study from Colgate University that found the following: “Lower financial income taxes stimulate innovation and enhance labor productivity in the long run.” More on this to come …