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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, January 23, 2012

Sullivan: Romney's Other Tax Break

Tax Analysts Martin A. Sullivan (Tax Analysts), Romney's Other Tax Break, 134 Tax Notes 267 (Jan. 23, 2012):

Was it creative destruction or vulture capitalism? Whatever you call what Mitt Romney did at Bain Capital, it is now a multi-pronged challenge to his presidential aspirations. Just the mention of investment shops like Bain can stir up resentment with the voters still looking for jobs and seething over the collapse of 2008.

Then there is the tax angle. When he left Bain in 1999, Romney negotiated a retirement package that gave him a share of the company's skyrocketing profits for at least a decade after his departure (Buyout Profits Keep Flowing to Romney, The New York Times, Dec. 18, 2011). The bulk of those profits were carried interest -- consulting fees paid to managing partners conditioned on upside gain for investors. The payouts were likely taxed at 15 percent. For a man with an estimated net worth of a quarter-billion dollars, a tax rate lower than middle-income families' does not sit well with voters who are daily reminded of increasing inequality, especially when Romney is proposing a plan that cuts taxes on the rich and raises taxes on the poor (Tax Policy Center, The Romney Tax Plan, Jan. 5, 2012).

Just as many Wall Streeters feared, Romney's rising presidential fortunes are threatening their monetary fortunes. The long-simmering debate about the tax treatment of carried interest is being reignited. On January 18 House Ways and Means Committee ranking minority member Sander M. Levin, D-Mich., announced his plans to reintroduce legislation to treat carried interest as ordinary income rather than capital gains. This is just the opening salvo. If Romney wins the Republican nomination, the president's populist reelection campaign will ensure that the carried interest controversy goes prime time.

Despite the media coverage of everything Romney and Bain, there is another significant tax policy issue concerning the business that has been left unmentioned. Like all investment houses that do leveraged buyouts, Bain created value for its investors by increasing debt levels and reducing taxes of its target companies. Bain profited from a dangerous flaw in our corporate tax that subsidizes destabilizing financial structures.

Distribution of $40 Million of Operating Income Before and After a Leveraged Buyout

Source: Example from Joint Committee on Taxation, Present Law and Background Relating to Tax Treatment of Business Debt, JCX-41-11, July 11, 2011, p. 70.

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