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Moving Past Attacks on Tax Rates

As we approach the fourth GOP primary in Florida this week, the lead in national polls has been alternating, on an almost-daily basis, between Former Speaker Newt Gingrich, who has surged since his recent victory in South Carolina, and former Massachusetts Governor Mitt Romney.

Romney’s relative decline in the polls has seemingly been a consequence of the successful shift in his opponents’ focus from ‘RomneyCare’ to his multi-million dollar fortune and alleged 15% income tax rate, which has served to portray him as a disconnected elite.

The concrete evidence available in the tax returns Romney released on Tuesday has fueled these recent attacks. Unfortunately for Romney, on that very same Tuesday, President Barack Obama took the opportunity in his State of the Union address to lambast tax rate inconsistencies. As part of his ongoing ‘fairness’ narrative, which he is using as one of the foundations to his 2012 reelection campaign, Obama regularly points to his friend Warren Buffett’s secretary, whose tax rate is apparently double that of the Oracle of Omaha himself. He made sure to bring the point home on Tuesday, even strategically inviting Buffett’s secretary to sit behind Secretary of State Hillary Clinton at the address.

Yet, a quick overview of taxation as a way for government to provide incentives reveals that Romney’s effective tax rate of 15% is not as absurd and detrimental as Obama and Gingrich have made it out to be.

To illustrate, let us compare two hypothetical individuals: Ivan the Investor and Joe the Engineer (perhaps the nephew of a once-famous Joe the Plummer…), who both have $1 million in wealth. Joe chooses to keep his $1 million with the bank, makes $100,000 a year working his engineering job, and is in the 35% income tax bracket. Joe’s income is risk-free and the rest of his wealth is safe in the bank. Ivan, on the hand, uses his entire $1 million to buy a business that sells widgets. He expects that by the end of the year, the business will increase its number of customers and he will be able to sell it for $1,100,000. His expected annual income will therefore be $100,000 – the same as Joe’s. The difference is that Ivan is putting his wealth at risk and should the widget business go bankrupt, he would lose his entire $1 million.

One of the foundations of economic theory is that investment drives growth and creates wealth. Government policy therefore seeks to give incentives for people to invest. To compensate Ivan for risking his money, the government needs to give Ivan a favourable tax rate, called “capital gains” tax. In the U.S case, this tax rate is 15%, while Canada’s capital gains tax varies but rarely exceeds 22%. Larger European countries usually have capital gains taxes between 25% and 30%, still far inferior to income tax rates – a general rule for most countries. Many countries, such as Switzerland, the Netherlands, Turkey, and even Iran, have no capital gains at all.

The reality that Mitt Romney’s tax rate is less than 15% shouldn’t be used against him. Rather, it should be recognized that stimulating investment in this manner helps grow the economy. In a sense, Romney is investing in America. So let’s move the discussion onto something more relevant to his actual candidacy.

–  Murray Lewis

 

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2 comments

  1. The reason that Mitt Romney’s tax rate is such an issue to his candidacy is because it is yet another example of “ivory tower syndrome.” Your example of Ivan and Joe had your investor risking his entire fortune on a company. There is no way that this applies to people like Mitt Romney. He’s not some entrepreneur who could go bankrupt any minute. It’s wrong to make someone like Romney seem brave for being an investor. He made all his money by buying companies and breaking them up…wonderful for the job market.

  2. This is a biased analysis, IMO. You forget that the engineer also risked his time and money, by investing in an education, taking out student loans etc. The money the engineer keeps in the bank will be given out as loans to businesses, which is as good as direct investment for the economy. You fail to justify, or even consider, the many reasons why one type of income deserves a lower tax rate than the other kind; you simply beg the question with a poor analogy.

    And the appeal to patriotism in the last paragraph is particularly face-palm worthy.

    That said, I actually agree with your conclusion. Cap gains should be kept low, gov’t should encourage investment, and there are more important things to discuss in this election.

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