Middle-income entrepreneurs in the UK can end up handing over more than half their hard-won earnings in taxes of one sort or another. So it is indeed shocking, but not really surprising, that US Presidential Candidate Mitt Romney, who is worth an estimated $250 million, paid taxes of “only 13.9%” on the $43 million he made over the last two years.
As usual, however, the media headlines do not tell the whole truth. A more accurate figure may be 14.5% rather than the 13.9% which was widely reported because it made a better story. Most reports also ignore the fact that this figure refers only to federal taxes: Americans pay state and local taxes on top of this. Finally it should be stressed more than it has been that this effective tax rate is an average over the whole income and should not be confused with the headline marginal rates that are payable on only part of the income of higher earners – the notorious 50% in the UK.
All that said, it does still shock how the effective rate paid by Mr Romney is much lower than that paid by many who are a lot poorer. There is no serious suggestion that Mr Romney has done anything illegal or dishonest. On the contrary, it is surely to his credit that he gave about $7 million to charity, which is tax deductible in the US and therefore a major factor in the relatively low marginal rate. He should not be condemned for generosity.
Nor should he be criticised, as a man in his 60s, for being retired from active business and living off his investments. Income from investments is taxed at a lower rate, as capital gains. At first glance, it does seem absurd that the tax rate on “unearned income” is lower than that on “earned income”. Yet most “unearned income” actually comes from the investment of income previously earned, so it seems unfair to tax it twice at the full rate.
In any case, Mr Romney has only done what we all do: arrange our finances to minimise our tax liability under the existing system. It is the system that is wrong.
Governments with high marginal tax rates know that they are economic nonsense but keep them for purely political reasons: they give the impression that they are “soaking the rich”, which usually goes down well with the vast majority of the voters who do not consider themselves rich. In order to prevent the rich disappearing, and most of their countries’ economies with them, these governments have almost invariably undermined the high headline rates of tax by a complex, but discreet, system of write-offs and loopholes. These tend to be more accessible for the super-rich than for middle-earners. This is why a flat rate tax would be both fairer and more efficient.
The most significant thing about Mr Romney’s tax returns is that they run to more than 500 pages.