TaxProf Blog

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

Wednesday, September 12, 2012

Bartlett: Mitt Romney, Carried Interest and Capital Gains

New York Times:  Mitt Romney, Carried Interest and Capital Gains, by Bruce Bartlett:

A key reason for Mr. Romney’s low tax rate is that a very substantial amount of his income comes from capital gains – 51% in 2011 and 58% in 2010. Capital gains, no matter how large, are taxed at a maximum rate of 15%, whereas wage income can be taxed as much as 35% by the income tax plus taxes for Medicare and Social Security. The latter two are not assessed on capital gains.

The New York Times recently commented in an editorial that while the carried interest loophole is unjustified, the core problem is lower tax rates on capital gains generally. Said The Times, “As long as income from investments is taxed at a lower rate than income from work, there will be no stopping the search for ways, legal or otherwise, to pay the lower rate.”

The view that capital gains should be treated as ordinary income for tax purposes is one that is widely shared by liberal tax reformers. They got their wish, briefly, from 1987 to 1990 because Ronald Reagan agreed to raise the tax rate on capital gains to 28% from 20% in return for a reduction in the top rate on ordinary income to 28% from 50%, as part of the Tax Reform Act of 1986.

There are three big problems, however, with taxing capital gains at the same rate as ordinary income.

First, even if that were the case, capital gains would still be treated more beneficially, because the taxes only apply to realized gains. ...

Second, there is a problem with inflation insofar as capital gains are concerned. Many academic studies have shown that a considerable portion of realized capital gains simply represent inflation, rather than real increases in purchasing power. ...

Third, it is a fact of life that those with great wealth are the principal beneficiaries of the capital gains tax preference, and they exercise influence in our political system far out of proportion to their numbers. ...

[I]t is a pipe dream to believe that eliminating the capital gains preference is the key to fixing the carried interest loophole. It can and should be addressed by treating carried interest as ordinary income, without requiring that all capital gains be taxed as ordinary income.

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Comments

"First, even if that were the case, capital gains would still be treated more beneficially, because the taxes only apply to realized gains."

Is Bartlett serious in calling this a problem, or is he just trying to fool some of the less sophisticated people who read his articles? Unrealized gains are paper gains, your stock appreciation today could be gone when the market tanks tomorrow (as the Facebook IPO reminded us recently). As we all learned in Tax 1, the key to income is a recognition event.

You can't spend your capital gain, you can't do anything until you realize it. (yes I know the ultra-wealthy can take out loans against their appreciated securities - but that is a different problem with potential solutions other than taxing unrealized gains).

Comments like Bartlett's simply remove any seriousness from one's entire argument.

Posted by: Todd | Sep 12, 2012 5:28:45 AM

Carried interest is clear proof rich people can buy off politicians.

There should be a clear line between short-term and long--term gains, and inflation adjustment for long-term gains.

Posted by: save_the_rustbelt | Sep 12, 2012 6:21:48 AM

1) no reason not to raise the rate

2) okay, that's a discussion point

3) again, not a reason not to raise the rate

Posted by: the real anon | Sep 12, 2012 7:27:13 AM

With all the discussion of fairness and equality, tax rates and tax reform there should be a national discussion of whether there should be only one rate for all types of income. If we don't we have decided that labor should be taxed higher than capital investment and therefore have given subsidies to those who can afford to invest in capital. Does it deserver a break, is it fair?

The fairest tax is one tax for all types of income.....one rate....no talking about job growth....or other economic theories.

It appears that discussion will never happen because most economists believe Capital investment should be subsidized by lower rates and encouraged.

Posted by: Sid | Sep 12, 2012 7:54:50 AM

If capital gains are treated as ordinary income, shouldn't capital losses be treated as ordinary losses, including the ability to create net operating losses?

Posted by: Whitey | Sep 12, 2012 8:30:20 PM