Romney: A Total Failure on Double Taxation

Last night’s GOP debate did nothing to change my sour opinion of Mitt Romney.

During a discussion about tax reform, he attacked Newt Gingrich for the supposed crime of not wanting to double tax capital gains. Here’s how Politico reported the exchange.

Newt Gingrich joked about Romney’s 15 percent tax rate, saying: “I’m prepared to describe my flat tax as the Mitt Romney flat tax.” Romney jumped in to ask: Do you tax capital gains at 15 percent or zero percent? Gingrich’s answer: Zero. “Under that plan, I’d have paid no taxes in the last two years,” Romney said, alluding to the fact that all his income is from investments.

Romney’s remarks are amazingly misguided. Getting rid of the capital gains tax doesn’t result in a tax rate of zero. It simply means that there is no second layer of tax on top of the punitive 35 percent corporate income tax.

I’ve had to correct Warren Buffett when he makes this mistake. One would think, though, that GOP presidential candidates would have a better understanding of taxation.

In addition to being wrong on policy, Romney also is politically tone deaf. By demagoguing against Gingrich’s tax plan, he lends credibility to the dishonest claims that his personal tax rate is “too low.”

In a column for today’s Wall Street Journal, John Berlau and Trey Kovacs of the Competitive Enterprise Institute explain how the GOP candidates should deal with this issue.

The former Bain Capital CEO and Massachusetts governor caused a brouhaha last week when he estimated the tax rate on his investment income at 15%. “How unfair!” pundits exclaimed, noting that the top marginal rate for wage income is more than 30%. The tax rate on investors is unfair, but for the opposite reason. Our tax code layers taxation of dividends and capital gains on top of a top corporate tax rate of 35%—which even President Obama acknowledges is one of the highest in the world. …This double taxation brings the effective tax rate on investment income to as much as 44.75%. In other words, after the combined top tax rates hit $100 of corporate income, $55.25 remains for the investor. And this figure doesn’t even include various state and local taxes, or the death tax. Moreover, like the rest of us, Mr. Romney paid income taxes before investing… Mr. Romney and other presidential candidates should use the opportunity of releasing their tax returns to make an important policy statement. They should include not only their individual returns, but information about the taxes their corporations pay. …In this way the candidates can help explode the myth of the U.S. as a low-tax nation. As Cato Institute tax experts Chris Edwards and Daniel J. Mitchell write in their book, “Global Tax Revolution,” while the U.S.’s “overall tax burden . . . is lower than in many other nations,” the country “imposes more punishing taxes on savings and investment than many advanced economies.” The most popular tax reforms—from the “9-9-9 plan” of former candidate Herman Cain to flat tax proposals—all have in common the reduction or elimination of double taxation on investment. …If the traditional disclosure of tax returns is elevated into a “teachable moment” about the burdens of double taxation, all Americans could be winners.

The authors are very kind to reference the book Chris and I wrote, but I mostly like this article because it does such a good job of explaining double taxation.

I made many of the same points in my video on capital gains taxation.

And keep in mind that the capital gains tax isn’t indexed for inflation, so the rate of double taxation in many cases is far higher than these estimates suggest.

As illustrated by this chart, double taxation is a serious self-inflicted barrier to American growth and competitiveness. Too bad Republicans are too short-sighted to address this issue intelligently.

Milton Friedman Talks Inheritance Tax

Milton Friedman was never one to shy away from debate, but was a master at answering hostile questioning with persuasive economic reasoning. Here’s his take on the death tax:

Explaining the Perverse Impact of Double Taxation with a Chart

Whether I’m criticizing Warren Buffett’s innumeracy or explaining how to identify illegitimate loopholes, I frequently write about the perverse impact of double taxation.

By this, I mean the tendency of politicians to impose multiple layers of taxation on income that is saved and invested. Examples of this self-destructive practice include the death tax, the capital gains tax, and the second layer of tax of dividends.

Double taxation is particularly foolish since every economic theory – including socialism and Marxism – agrees that capital formation is necessary for long-run growth and higher living standards.

Yet even though this is a critically important issue, I’ve never been satisfied with the way I explain the topic. But perhaps this flowchart makes everything easier to understand (click it for better resolution).

There are a lot of boxes, so it’s not a simple flowchart, but the underlying message hopefully is very clear.

1. We earn income.

2. We then pay tax on that income.

3. We then either consume our after-tax income, or we save and invest it.

4. If we consume our after-tax income, the government largely leaves us alone.

5. If we save and invest our after-tax income, the government penalizes us with as many as four layers of taxation.

You don’t have to be a wild-eyed supply-side economist to conclude that this heavy bias against saving and investment is not a good idea for America’s long-run prosperity.

By the way, Hong Kong’s simple and fair flat tax eliminate all those extra layers of taxation.

That’s the benefit of real tax reform such as a flat tax. You get a low tax rate, but you also get rid of double taxation so that the IRS only gets one bit at the apple.

Huntsman Plan Targets Double Taxation

Another proposed plan by a presidential candidate is tackling the issue of destructive double taxation. Former Utah Governor Jon Huntsman unveiled today his economic plan, titled “Time to Compete: An American Jobs Plan.” From the overview:

Eliminate The Taxes On Capital Gains And Dividends In Order To Eliminate The Double Taxation On Investment. Capital gains and dividend taxes amount to a double-taxation on individuals who choose to invest. Because dollars invested had to first be earned, they have already been subject to the income tax. Taxing these same dollars again when capital gains are realized serves to deter productive and much-needed investment in our economy.

Now if he just throws in the death tax, he can hit the double taxation trifecta.

Warren Buffett’s Fiscal Innumeracy

Warren Buffett’s at it again. He has a column in the New York Times complaining that he has been coddled by the tax code and that “rich” people should pay higher taxes.

My first instinct is to send Buffett the website where people can voluntarily pay extra money to the federal government. I’ve made this suggestion to guilt-ridden rich people in the past.

But I no longer give that advice. I’m worried he might actually do it. And even though Buffett is wildly misguided about fiscal policy, I know he will invest his money much more wisely than Barack Obama will spend it.

But Buffett goes beyond guilt-ridden rants in favor of higher taxes. He makes specific assertions that are inaccurate.

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

His numbers are flawed in two important ways.

1. When Buffett receives dividends and capital gains, it is true that he pays “only” 15 percent of that money on his tax return. But dividends and capital gains are both forms of double taxation. So if he wants honest effective tax rate numbers, he needs to show the 35 percent corporate tax rate.

Moreover, as I noted in a previous post, Buffett completely ignores the impact of the death tax, which will result in the federal government seizing 45 percent of his assets. To be sure, Buffett may be engaging in clever tax planning, so it is hard to know the impact on his effective tax rate, but it will be signficant.

2. Buffett also mischaracterizes the impact of the Social Security payroll tax, which is dedicated for a specific purpose. The law only imposes that tax on income up to about $107,000 per year because the tax is designed so that people “earn” a corresponding retirement benefit (which actually is tilted in favor of low-income workers).

Imposing the tax on multi-millionaire income, however, would mean sending rich people giant checks from Social Security when they retire. But nobody thinks that’s a good idea. Or you could apply the payroll tax to all income and not pay any additional benefits. But this would turn Social Security from an “earned benefit” to a redistribution program, which also is widely rejected (though the left has been warming to the idea in recent years because their hunger for more tax revenue is greater than their support for Social Security).

If we consider these two factors, Buffett’s effective tax rate almost surely is much higher than the burden on any of the people who work for him.

But this entire discussion is a good example of why we should junk the corrupt, punitive, and unfair tax code and replace it with a simple flat tax. With no double taxation and a single, low tax rate, we would know that rich people were paying the right amount, neither too much based on class-warfare tax rates nor too little based on loopholes, deduction, preferences, exemptions, shelters, and credits.

So why doesn’t Buffett endorse this approach? Tim Carney offers a very plausible answer.

For more information about why class-warfare taxes are misguided, this video may be helpful.

George Will: Eliminate Estate Tax for Economic Recovery

In the midst of explaining how to fix the economy in an interview with PBS’ Charlie Rose, George Will had this to say about the death tax:

“I would eliminate the death tax. I don’t know why death is a taxable event in this country. No more estate taxes. Eliminate — go back to the classic — no taxation without respiration, that’s right. Go back to the classic Bill Bradley/Ronald Reagan tax reform of 1986. Lower the rates by eliminating loopholes and exceptions.”

Gingrich Joins Chorus to Reduce Double Taxation

Following in the footsteps of two other Republican presidential candidates, Newt Gingrich has promised to eliminate the capital gains tax if elected:

In a broad-ranging speech, Gingrich … promised to make current tax rates permanent, eliminate the capital gains tax and slash corporate taxes in an effort to lure capital back into the United States.

Ideally, we’d like to see every candidate in both parties looking to eliminate harmful double taxation. Unfortunately, President Obama wants to do the opposite. But while we continue to hope he has a change of heart, the more Republican candidates willing to strike a pro-growth position against double taxation, the better the odds of seeing a real change in tax policy become.

Candidates Talk Taxes in Republican Debate

There were a couple of mentions of double taxation in the recent CNN sponsored Republican primary debate in New Hampshire.

Herman Cain took the most definitive stance, pledging to eliminate the capital gains tax:

CAIN: The thing we need to do is to get this economy boosted. This economy is stalled. It’s like a train on the tracks with no engine. And the administration has simply been putting all of this money in the caboose.

We need an engine called the private sector. That means lower taxes, lower the capital gains tax rate to zero, suspend taxes on repatriated profits, then make them permanent. Uncertainty is killing this economy. This is the only way we’re going to get this economy moving, and that’s to put the right fuel in the engine, which is the private sector.

Rick Santorum also mentioned cutting the capital gains tax, but took a more modest position:

We need to cut the capital gains tax in half which others have proposed but for manufacturers we need to give a five-year window where we cut it to zero.

DeMint Amendment Would End Death Tax

Senator DeMint is proposing an amendment that would eliminate the death tax. The death tax repeal is being included in an amendment that also ends ethanol mandates. According to DeMint’s office:

“Unfortunately, Washington’s bad ethanol policies don’t end with just subsidies and tariffs, we must also repeal the mandate, which my amendment would do,” said Senator DeMint, whose amendment will also permanently repeal the death tax.  “The best way to help family farmers is not with mandates, subsidies, and protective tariffs.  We can help farmers and stimulate the economy by repealing the unfair death tax, which cripples family farms and small businesses all over this country.”

In the previous Senate, and due to Majority Leader Harry Reid’s obstinance, DeMint was forced to use a procedural move – which would have required 67 votes – in an effort to prevent the death tax from returning for 2011. It didn’t matter really matter, though, as only 39 Senators supported the bill. That number will certainly increase with the new Senate, but it will still require some who previously voted down the idea to change their minds in order for DeMint’s new amendment to pass.

 

Small Business Owner Cites Death Tax Burden

The Oregon legislature has been debating whether to raise its state death tax. In response, small business owner Peter Nelson explains how the death tax affects their ability to increase employment:

My grandfather started Marc Nelson Oil Products as a one-man shop. Today we employ 30 in the Salem area. We’d like to employ more.

…Despite what some may think, family businesses are not awash in cash; our resources are tied up in equipment, salaries, facilities and the like. The more money diverted to estate tax planning and to estate tax payments when I die, the less resources for expansion and hiring today and in the future.