When politics and the economy collide: What level of taxation is fair?

Posted Monday, September 24, 2012 in Analysis

When politics and the economy collide: What level of taxation is fair?

Source: Tax Policy Center

by Gina Hamilton

During his 60 Minutes interview, former governor Mitt Romney was asked about the fact that he showed a 14 percent effective tax rate for 2011 ... and if he had taken a full deduction for charitable donation (which he can still do by amending a return next year), his rate would have been closer to nine percent.  Was that fair, he was asked by CBS' Scott Pelley, when middle class taxpayers earning $50,000 pay closer to 20 percent?

"It is a low rate," Romney said. "And one of the reasons why the capital gains tax rate is lower is because capital has already been taxed once at the corporate level, as high as 35 percent."

When pressed on whether or not he believes that rate is fair, Romney said he thought it was the "right way to encourage economic growth -- to get people to invest, to start businesses, to put people to work."

A lot of people work for corporations in which the capital has already been taxed once at the corporate rate, but they also pay income tax at a higher level than Romney and his family pay.  For instance, a lineworker making $65,000 at Ford Motor Company works for a corporation which pays 35 percent in corporate taxes.  But that line worker pays 25 percent in income tax, more than 10 percent more than the Romney family pays. 

And the Romney family, earning over $13 million last year with their low tax burden, has not started a business in the last two years or put anyone to work, according to their own tax returns.  In 2011, they spent a total of $4000 on household help, which is curious in itself, since that rate would be far below anything approaching minimum wage.

The lineworker, with a far more modest income, is far more likely to have put someone to work ... a babysitter, perhaps, or a home health aide to look after an aging parent, while he or she was working in the factory all day.  He or she is also far more likely to have added to the local economy by spending the majority of income, while the Romney family sheltered the vast majority of its income, much of it overseas.

So is a low capital gains rate, at least when it comprises the total of one's very high income, even fair taxation?

Dean Baker, from American Prospect, says no.  He makes the following points about a low capital gains rate:

 

 

Romney's wealth is mostly income that was deferred so that he could take the funds at a lower capital gains rate rather than a higher personal income rate.  If he had taken the funds he was owed by Bain Capital at the time he was working there, he would have paid between 35 and 40 percent, depending on the year.  In general, people who work for companies like Bain take 20 percent of their income as income, but 80 percent as deferred income of many kinds. 

However, an organization called "Shared Economic Growth" says that a low capital gains rate actually spurs economic growth.  Here are their points:

 

However, the ten years, in which capital gains has been very low, has not seen the economic stimulus that this organization and others would have predicted.  Indeed, companies are sitting on their capital now and not investing it in new business or other stimulative projects.

Unless some unexpected compromise is reached before the end of the year, short term capital gains (on capital held for less than a year) will rise in 2013 to 39.6 percent (the highest income tax rate) for the highest incomes, and long term capital gains (on capital held for a year or longer) rate will rise to 20 percent, with an additional 2 percent off if the capital is held for five years or more.  It is thought that the short term rate rising so high will deter speculation to an extent.

So what is a fair capital gains rate?  Capital gains was never as low as it is today throughout history.  Throughout most of the postwar period until the late sixties, the long term capital gains rate was 25 percent, with short term gains treated as ordinary income.  The long term rate rose in the late sixties to about 40 percent, and stayed high until the 80s, when it was dropped to 20 percent during a brief time under Reagan (he raised them in 1987 and left them at 28 percent through the Bush years).  Under Clinton, it rose again to 29 percent. During most of that time, business starts were high, investment was strong, and the economy was robust.  The rate was lowered to 15 percent as part of the Bush era tax cuts in 2003.

A rate of at least 25 percent for long-term gains, while taxing short term gains at the ordinary income rate, seems rational.  It is also correlated with steady economic growth for decades, strong private sector growth, and enough funding to establish important and necessary public projects.  It is correlated with low unemployment and a higher standard of living for most workers.

The current taxation rates in general, however, have had the opposite effect on the economy.  Even before the economic collapse in 2007, led by speculation in several key sectors, including housing and commodities, the economy from 2003 on was basically flat.  A short term recession following 2001 led to a jobless recovery, and high income inequality.

Since low taxation has not had the desired effect, it is time to consider alternatives.

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