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Home Publications Blogs Beat the Press All Economists Do Not Agree that Mitt Romney's Tax Rate Should be Low

All Economists Do Not Agree that Mitt Romney's Tax Rate Should be Low

Monday, 24 September 2012 14:15

Any time you hear anyone tell you that "all economists agree," get out your gun. Unless the question pertains to the shape of the earth, this is almost certainly not true.

It is most definitely not the case that economists agree that Mitt Romney should be paying his current 14.1 percent tax rate or less as Washington Post readers were told by Dylan Matthews today. Matthews rests his case on some arguments in the literature concerning scenarios in which we both look to an infinite future horizon and we have identically situated individuals, meaning that we all have the same wealth and the same opportunity to gain income. When these assumptions are relaxed, the case for preferential treatment of capital income becomes considerably weaker, as argued in a recent Journal of Economic Perspectives article by Peter Diamond and Emmanuel Saez, two of the most prominent public finance economists in the world.

The second point here is probably the more important. If we have some individuals who inherit immense wealth so that they can live entirely off their capital income and other individuals who must work for their income, a policy that subjects capital income tax to a lower rate of taxation than labor income means that we are taxing the rich at a lower rate than the middle class and poor. It is difficult to see how this is either efficient (we are giving disincentives to work for middle class people as a result of a higher than necessary tax rate) or fair.

Furthermore, as a result of having a lower tax rate on capital income than labor income we are giving people an incentive to game the tax code by concealing labor income as capital income. While most workers may not have much opportunity to play such games, higher end workers, such as doctors or lawyers with their own practices would have ample opportunities for such gaming. This is both unfair and leads to a waste of resources as these people employ accountants to rig their books.

In fact, Mitt Romney and his firm Bain Capital were experts at such gaming. They routinely negotiated deals that changed management fees, which would be taxed as normal income, into carried interest which would be taxed at the capital gains tax rate. Few, if any, economists would agree that allowing for such deals is good policy.

Finally, even if economists might in general agree that it makes sense to have a lower tax rate on capital income than labor income, it does not at all follow that they think that Mitt Romney was paying enough in taxes. The article by Diamond and Saez suggests a top marginal tax rate of around 70 percent. In this case, a 50 percent tax rate on capital gains would still provide a substantial benefit to earners of income from capital. That rate would be more than three times the tax rate that Mitt Romney paid on his income.

So when you get your score card out remember to put down that many, perhaps most, economists believe that Mitt Romney should pay more money in taxes. Don't let the Washington Post fool you.

Comments (15)Add Comment
written by fasteddie, September 24, 2012 3:25
Can you explain what the rationale is for the taxes on WORKING ( wages) being so much higher than for just OWNING ( capital gains). Things like Federal courts really only benefit the rich and the corporations owned by the rich ( patents, etc ) . Similarly, the military is *generally* in place to protect American corporate ( i.e. owned by the rich) interests abroad. But the rich pay LESS?? How does this make any sense?
written by skeptonomist, September 24, 2012 3:27
The current rate on capital gains and dividends is ridiculous, but so is the definition of "long-term" which qualifies for the low rate - 366 days. A change of this, maybe even to a little as 5 years, might make a big difference in "investment" strategy.
Romney thinks his taxes are both too high and too low
written by Robert Salzberg, September 24, 2012 3:48
Mitt Romney dissed the most fundamental of Republican principles of never paying more taxes than you have to just for the optics of saying he paid at least 13% in taxes. Of course, Romney, like everyone else, is free to amend his return up to 3 years so he can always claw the money back later. But for now, Romney paid over 9 years of median American family income extra for last year's taxes so he must think his taxes are too low.

Romney's proposed tax policies imply Romney thinks his taxes are too high:

“Romney also paid $675,000 under the Alternative Minimum Tax (AMT). If his own tax plan, which eliminates the AMT, had been in place in 2011, he would have saved himself an additional $675,000, or one third of his entire federal tax bill, and reduced his effective rate to 9 percent."

Rawlsian Veil of Ignorance: Having It Both Ways Makes It Irrelevant
written by Last Mover, September 24, 2012 4:03
Matthews rests his case on some arguments in the literature concerning scenarios in which we both look to an infinite future horizon and we have identically situated individuals, meaning that we all have the same wealth and the same opportunity to gain income.

Who would've known. Conservatives have finally discovered the Rawlsian Veil of Ignorance - in reverse. The original version means given unknown outcomes combined with unknown opportunity beforehand (at some early starting line in economic life), certain outcomes associated with essential minimal needs should be made equal.

In reverse as modeled by Matthews, it would mean while opportunities are equal along with equal wealth, outcomes are as unequal as necessary, implied to be driven by differences in individual effort and capability.

So it's Catch-22. The original Rawlsian Veil of Ignorance is rejected as safety net socialism and in reverse, it's made irrelevant by assuming away the possiblitity of unequal opportunity along with equal wealth assumed at the starting line, so no safety net is necessary.
written by AlanInAZ, September 24, 2012 4:43
The earnings from equities in my 401k will be taxed as ordinary income when withdrawn. It seems not all capital investment income is equal.
President Ronald Reagan Thinks Romney's Taxes Are To Low
written by Robert Salzberg, September 24, 2012 7:05
President Ronald Reagan believed that income taxes on work and taxes on wealth should be exactly the same. President Reagan's Tax Reform Act of 1986 increased taxes on long term capital gains from 20% to 28%, a net 40% increase. How many of today's House Republicans would say they agree with President Reagan?
written by liberal, September 24, 2012 9:12
It's actually much worse.

A lot of capital gains isn't from "capital" at all, but from things like appreciation in the value of real estate. Since real estate appreciation is all due to land (structures and other improvements must, in an economic sense, depreciate), it can be taxed at 100% and not distort economic activity. (Even Adam Smith, writing pre-Ricardo, understood this: Both ground- rents and the ordinary rent of land are a species of revenue which the owner, in many cases, enjoys without any care or attention of his own. The annual produce of the land and labour of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before. Ground-rents, and the ordinary rent of land are, therefore, perhaps the species of revenue which can best bear to have a peculiar tax imposed upon them..) Furthermore, the people who pocket gains on things like commercial real estate are mostly quite wealthy.
written by Factotum, September 25, 2012 6:24
Please don't say that stuff about getting out your gun when you disagree with something. Here in New Hampshire, where virtually everyone is armed on the streets, it is all too likely. The thing to do when someone disagrees with you is not to shoot them or threaten them but argue with them as you have been doing so well all these years.
written by kharris, September 25, 2012 6:56
Oh, Last Mover, what have you done? Now that you've shown a philosophical basis for Matthews' case, however badly twisted, you know they are gonna run with it. Sometime soon, we're going to hear an argument for lower taxes on capital that begins "Even a benighted socialist like Rawls knew..."
Reagan's take on taxes for millionaires
written by Robert Salzberg, September 25, 2012 7:29
"We are going to close the unproductive tax loopholes that have allowed some of the truly wealthy to avoid paying their fair share. They sometimes made it possible for millionaires to pay nothing when a bus driver was paying 10 per cent of his salary and that's crazy. Do you think the millionaire ought to pay more taxes than the bus driver?"

GDP Growth Rate Since Long Term Capital Gains Rates Cut in Half
written by Robert Salzberg, September 25, 2012 8:05
Since 1998, long term capital gains rates have been cut in half. If low taxes on investment is the fuel that drives our economy, than GDP growth rates would have seen a steady climb up as rates went down. The attached linked graph shows no such correlation:

written by Robert Waldmann, September 25, 2012 10:27
Indeed. I might add http://rjwaldmann.blogspot.it/...it-is.html
The standard argument for a 0 tax rate on capital income is based on the mathematical result that, given very strong assumptions, the rate should go to zero as time goes to infinity. The approximation that 2012 is approximately infinity is absurd and standard.

Aside from blowing my own horn, I want to note the issue which you didn't stress. Standard analysis of taxes assumes Ricardian equivalence. In the real world high public budget deficits correspond to low national saving. It is painful for economists to model agents who ignore the intertemporal public budget constraint, but we are such agents.

Calculations of the effects of reduced taxes on capital income are based on the assumption that either public spending is cut or other taxes are increased. Policy makers decide that cutting taxes on capital income and changing nothing else will promote capital formation. In the real world this leads to budget deficits which crowd out private investment (when the economy is not in a liquidity trap).

This is a huge effect which is very plainly visible in the data. It is ignored, because it depends on irrationality (yes it could occur in an OLG model with rational agents but I'm talking about the real world).
Agree on shape of the earth?
written by Art Perlo, September 25, 2012 10:35
It is unfair to economists to say that they all agree on the shape of the earth. Although the performance of the profession indicates that most economists think the earth is flat, today there are still some who support the tradition of Adam Smith, Karl Marx and even Keynes in claiming that the earth is approximately spherical.
written by Wil Cummings, September 25, 2012 11:10
All are not? All refrigerators are not Frigidares. Are there no Frigidare fridges?
written by GT, September 25, 2012 9:03
I recall my Republican public finance professor explicitly state economists believe we should not show preference to different types of income.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.