Republican presidential candidate Mitt Romney fought back on Friday against Democrats’ claims that he paid no taxes in some years, releasing a letter from his accountants saying he paid an effective federal tax rate of at least 13.6 percent annually over 20 years.
Despite heavy political pressure, Romney stood firm in refusing to make those returns public, but followed through on an earlier promise to release his 2011 return. It showed he paid $1.9 million in taxes on more than $13 million in income – an effective tax rate of 14.1 percent.
OK, so Romney paid an effective tax rate of 14.1%. How does that compare to the rest of America? Well, here is a table from the Tax Policy Center showing the average effective tax rates Americans pay:
As you can see, Romney pays a higher effective income tax rate — 14.1% vs. 9.1% — than the average American. What’s more, he pays a higher effective income tax rate than the top four quintiles. (The fourth quintile pays an average rate of 5.5%, lower ones pay less.) That’s 80% of taxpayers.
Second, even if you include ALL taxes as TPC does — including payroll taxes — Romney still pays a higher effective tax rate than three out of five quintiles. That’s 60% of tax payers.
Now the reason Romney paid a relative low tax rate is because capital income is taxed at a preferential rate vs. labor income. Here is why that makes sense, via AEI’s Alex Brill and Alan Viard:
One way base broadening can impede tax neutrality is by amplifying the income tax’s inherent distortion between current and future consumption. Income taxation distorts resource allocation by penalizing saving and investment, thereby favoring current consumption over future consumption. True neutrality requires consumption taxation, not income taxation. Broadening the income tax base may increase the saving penalty, undermining the pursuit of economic efficiency.
We can illustrate this penalty with a simple example. Consider two individuals, Patient and Impatient, each of whom earns $100 in wages today. Impatient wishes to consume only today and Patient wishes to consume only “tomorrow,” which is many years in the future. Saving yields a 100 percent rate of return between today and tomorrow. With no taxes, Impatient consumes $100 today. Patient saves the $100, earns $100 interest, and consumes $200 in the future.
What happens with a 20 percent income tax? Impatient pays $20 tax on his wages today and consumes the remaining $80, which is 20 percent less than in the no-tax world. Patient also pays $20 tax and saves the remaining $80, earning $80 interest. However, $16 tax is also imposed on the $80 interest. That leaves Patient with $144, which is 28 percent less than in the no-tax world, compared to a mere 20 percent reduction for Impatient. The income tax imposes a higher percentage tax burden on Patient solely because she consumes later. The income tax’s penalty on saving causes an inefficient distortion of consumer choice and lowers the accumulation of national wealth and the long-run rise of living standards.
The current income tax system includes certain provisions that mitigate the saving penalty. Three of these provisions–the reduced tax rate on dividends and capital gains, the tax preferences for defined benefit plans, and the tax preferences for defined contribution plans–are among the top ten tax expenditures. These “preferential” provisions tend to promote efficiency by treating current and future consumption more neutrally. Base broadening that removes or curtails them may, therefore, damage economic efficiency.
Because the penalty on saving is an inherent feature of income taxation, it cannot be eliminated by income tax base broadening. The only way to eliminate the penalty is to replace the income tax with a consumption tax; in the above example, a consumption tax with a constant tax rate over time would have the same percentage impact on Patient and Impatient. In that respect, income tax base broadening is an imperfect substitute for consumption taxation, a reform that lies outside the scope of this Outlook.
Even if base broadening cannot remove the tax penalty on saving, it must not increase the penalty by removing provisions that ameliorate the penalty. To be sure, many of these provisions are poorly designed; the bewildering variety of tax-preferred savings plans creates needless complexity and is not the most effective way to ease the tax penalty on saving. Base broadening measures can be useful if they improve the design of these provisions without increasing the penalty on saving.