As a kid, I often would complain, “that’s not fair.” My whine often followed some injustice I suffered as a result of the perceived preferential treatment of my sister. The reply I heard was always the same: “Whoever told you life was fair?”
The older I get the more I realize how true that is. However, striving for fairness is laudable, even if getting there is impossible. The fairness concept has become a discussion topic lately relating to President Obama’s State of the Union address and highlighted in the tax returns released by a potential Republican opponent, Mitt Romney.
After being pressed by his primary opponents, Republican front-runner Romney relented on Tuesday and finally released his tax returns from last year and estimates for this year. They revealed that while he made around $21.7 million in taxable income in 2010, he paid federal income taxes of only around $3 million for an effective tax rate less than 14 percent.
Although never mentioning Romney by name, President Obama easily could have in dealing with this exact situation in his State of Union that night.
“Right now, because of loopholes and shelters in the tax code, a quarter of all millionaires pay lower tax rates than millions of middle-class households,” said Obama. “Tax reform should follow the Buffett rule: If you make more than $1 million a year, you should not pay less than 30 percent in taxes.”
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At first blush, this low effective tax rate for most millionaires seems to go against our whole notion of fairness. How is it possible that some of the wealthiest pay a lower rate than the rest of us? There must be some sort of insider shady deal going on, right?
Not necessarily. Most it is has to do with the way the tax code treats the income from investments versus income from wages.
“In my case, the taxable income was overwhelmingly capital gains and the first bite of the apple is at the corporate level,” Romney explained on a talk show after the State of the Union. “The reason we have a capital gains rate which is lower than the regular tax rate is because the corporations that we are getting a capital gain from have paid taxes themselves.”
What Romney is talking about is another attempt at the tax code to resolve an issue of tax fairness by eliminating something called double taxation. The investment income that receives this lower rate comes from the profits of corporations. Corporations are treated as separate taxable entities by the IRS and are taxed on their net taxable income at a rate of 35 percent.
So in that respect, a good chunk of taxes have already been taken out of the dividends and capital gains before they are ever received by the individual and taxed at his level.
All things being equal, profit from a corporation taxed at the maximum corporate rate and then passed on to the taxpayer and taxed at the maximum individual rate for capitol gains and dividend would have an effective tax rate of around 45 percent.
So when you look at it from that perspective, the double taxation and an effective tax rate close to 45 percent seem almost unfair in the opposite direction.
Of course, it is never that easy. With the numerous tax credits, exemptions and loopholes that a lot of corporations enjoy, many end up paying taxes at a rate much lower than the 35 percent. And perhaps that is really the point.
Tax fairness should not be so much about socking it to the rich guy that had either the good fortune or the hard work to make over $1 million. Instead, it is about creating a tax system where all businesses play by the same rules. It is about tackling the muddy waters of cleaning up our tax code and standing up to the special interests that will fight against reforms.
Until we do that, all this tax fairness talk is, well, unfair.
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Jason Tolbert is an accountant and conservative political blogger.