Mitt Romney’s tax disclosure on Tuesday should help him in his struggle against Newt Gingrich for the Republican nomination. But his 2010 and 2011 tax returns raise major questions about the fairness of the U.S. tax code, and will likely become exhibit 'A' if he debates President Obama over tax reform during the general election.
The partial release of his unfiled 2011 taxes will also generate intense interest in the days and weeks ahead because of what they failed to disclose: the make-up of his overseas holdings, which are held in blind trusts; the financial structure of the estimated $100 million held in an individual retirement account, where capital gains mount up tax free; or the contents of his prior tax returns.
In the past two years, Romney earned the largest share of his $42.5 million income from carried interest, dividends and capital gains. Such non-salary income is taxed at a 15 percent rate. The result was that after deductions for charitable donations to the Mormon Church and other non-profit entities, he paid just $6.2 million in taxes, an effective tax rate of 14.6 percent.
That’s not just a lower rate than his main competitor for the Republican nomination, who paid 31.6 percent of his $3.2 million income in taxes in 2010, or lower than President Obama, who paid 26 percent of his $1.8 million in income, it is a lower rate than Warren Buffett’s secretary, who famously paid a higher rate than her boss.
Romney has repeatedly argued on the campaign trail that he supportstax reform that will broaden the base of taxable income while lowering overall rates. But his plan has been short on details of how he would treat non-wage, non-salary income generated from accumulated wealth, which is how he collects most of his reported income. He did earn about $639,000 from speaking fees in the past two years.
The trustee of the blind trusts where Romney and his wife Anne have deposited most of their wealth stressed during a Tuesday morning briefing that his accountants at PriceWaterhouseCoopers were in full compliance with the tax code. “Gov. Romney has paid 100 percent of what he owes,” said R. Bradford Malt, an attorney at the Boston law firm of Ropes & Gray.
The single biggest component of Romney’s income came from so-called carried interest, which is income earned from managing other people’s money. Portfolio managers at companies like Bain Capital typically take two percent of the money they manage plus a 20 percent cut of any positive returns. Even though they have no capital at risk, their slice is treated like capital gains and taxed at the 15 percent rate. If it were treated like ordinary income, it would be taxed at a 35 percent rate.
Romney earned $13 million in carried interest over the last two years. “It isn’t fair to characterize carried interest as compensation when Gov. Romney hasn’t had any involvement in Bain since 1999,” said Balt. “The carried interest does represent the investments previously made by Gov. Romney in Bain Capital.”
However, the returns do not reveal the structures of the dozens of investment funds in the U.S. and abroad owned by the Romney family’s trusts. The Romney family fortune, depending on the financial disclosure statement, is estimated to be somewhere between $190 million and $250 million.
When pressed on Romney’s tax reform plan, a spokesman said, “The governor has not talked specifically about carried interest. He’s not interested in picking losers and winners like the Obama administration . . . He supports fundamental tax reform . . . a simpler, fairer and flatter tax structure.”
The president has proposed taxing carried interest like ordinary income. However, neither Democratic nor Republican Congresses have gone along after intense opposition by Wall Street lobbyists.
Tax experts say it is one of the most glaring inequities in the tax code. “Carried interest is the return you get from someone else’s capital, from managing someone else’s money,” said Edward Kleinbard, a law professor at the University of Southern California and former chief of staff at the non-partisan Joint Committee on Taxation. “There’s no plausible justification for getting a 15 percent rate on managing other people’s money.”
While proponents of taxing capital gains at lower rates claim it fosters job creation by encouraging greater investment by the well-to-do, few economists support that theory and tax reformers in previous generations have often taken aim at its preferential treatment. In fact, the tax reform plan backed by President Ronald Reagan and signed into law in 1986 established the same rates for both, which lasted until the early 1990s.
Romney’s advisers repeatedly pointed out that under Gingrich’s tax plan, his tax rate would be even lower. The former House Speaker wants to eliminate all taxes on capital gains and dividends, which would blow another huge hole in the federal budget. With Romney being a huge beneficiary of such a change, that could make Gingrich seem hypocritical in the parts of Florida that are semi-rural, industrial and agricultural, the areas where he polls strongest.
On the other hand, Romney as standard-bearer may be alienating Republican retirees who live in Florida’s well-off coastal enclaves, who’d rather not see their favored treatment in the tax code held up to public scrutiny.