Lil White Lies: Ineffective Tax Rates Part 1

Trying to determine a link gone bad at PolitiFact, I came across an interesting article in defense of Mitt Romney’s 13.9% tax rate from the Tax Foundation, one of PolitiFact’s oft-used sources. An article by William McBride is headlined “At least 90 Percent of Americans Have a Lower Income Tax Rate than Romney” complete with a large pie chart depicting by slice the range of rates Americans pay. Between this and another article disputing it from a website called “Just Facts” it would seem PolitiFact might rethink its position on a ruling of “Half True” for Obama stating that most people pay more taxes than Mitt Romney.

But there’s a lot of argument about what rate is being talked about, because it would appear that the Tax Foundation article concerns itself with federal income taxes only. And for that part, PolitiFact’s ruling was in agreement. However, it wasn’t in agreement when the payroll taxes were included. An article at Factcheck.org essentially said the same thing: “it depends.”

My conservative counterpart (in two posts) argues that if payroll taxes are included, so should corporate and excise taxes, as part of an overall effective rate. The corporate tax rate appears to be something, however, that all the fact-checkers seem to avoid, for a lot of good reasons. As noted in one PolitiFact tax-related ruling:

The burden for some taxes, including corporate taxes, excise taxes and estate taxes, are hard to attribute to individual returns, so we’ll set those aside. But one federal tax is straightforward to throw into our calculations: payroll taxes.

And since the fact-check is on Romney’s individual return, corporate taxes were not included. It’s not a direct, out of pocket tax like the payroll tax. It’s what’s known as an “imputed” tax, and it’s very difficult to measure:

We will assume that the corporate income tax falls entirely on capital income and that all financial assets (and not only corporate stock) bear the tax equally. Auerbach (2006) summarizes the literature on the incidence of the corporate income tax and points out that there is still considerable uncertainty on the question because of the inherent difficulty in measuring empirically the economy-wide incidence of the corporate tax.

“Just Facts” (which I like to call “Just Cherry-Picked Facts” because they appear to be only about “facts” right-wingers love) insists that the corporate tax be “incorporated” into Romney’s effective income tax rate, but proposes three scenarios in how it might be computed, resulting in an “effective rate” of anywhere from 18 to 26 percent. In other words, it’s not very accurate, because we don’t know how to apply it.

Not only that, they may have determined the rate based on too much of Romney’s income.  According to an article in Daily Finance on Romney:  (emphasis mine)

In 2010, he made $7.4 million from carried interest.

You haven't heard of carried interest? Basically, it's a share of investment income that goes to the private equity manager who oversaw the investment. Romney's carried interest income doesn't come from dividends on stock he owns, nor from the sale of stock that he once owned. The money wasn't generated from income that he had already paid tax on.

So where does it figure in Just Facts’ Excel spreadsheets? It says Romney had $12.5 million in capital gains. The reason for the “double taxation” claims you often hear from conservatives is that the investor (Romney) has already paid taxes on his initial investment; but assuming it isn’t generated from income that he had already paid tax on, then  in a sense it offsets the corporate tax, since no taxes were paid to begin with. So, re-calculating by subtracting $7.4 million from the capital gains results, at the “75%” scenario, in a tax rate of 20.2%. This is getting confusing.

If you read the link to the Wall Street Journal in the PolitiFact ruling describing “carried interest” you’ll find that there’s also been a court judgment that the carried interest should be considered compensation, and that there’s been a lot of pressure from various sources to change the law so that it’s taxed accordingly. This would definitely have a "what-if" impact on Romney’s taxes as well, increasing them to almost 21% based on the $7.4 million carried interest. In other words, he would pay 50% more if not for the carried interest, so White and Just Facts wouldn’t have to fool around with imputed corporate taxes to help prove poor Romney pays too much.

Wrote Judge David Gustafson: "Neither the contingent nature of [Mr. Dagres's carried interest] nor its treatment as capital gain makes it any less compensation for services." The opinion also likened his business to that of "stockbrokers, financial planners, investment bankers, business promoters, and dealers"—all of whom pay taxes on their income at rates up to 35%.

Just Facts also says that “Specifically, CBO found that households in the middle 20% of the U.S. income distribution paid an effective federal tax rate of 11.1% in 2009.” But the Tax Policy Center’s Tables—utilized by PolitiFact and cited by FactCheck, are for 2011, so which would be more relevant? It’s possible this may be correct for percentage of cash income, but compared to the adjusted gross income (15.5) it appears to be much too low. What Just Facts doesn’t give us the facts about, though, is that the rate for 2009 is distorted due to the events of that year: the stock market bottoming out in its collapse and the rise in unemployment due to the financial meltdown in 2008. A snip from a chart from the Tax Foundation (below) shows how revenue dropped in 2009, which would be reflected in the 11.1% number.

In addition to failing to account for Romney’s corporate tax burden, Farley measures the income of the middle class in a way that skews his analysis even further. When selecting a denominator to calculate the middle-class tax burden, Farley uses adjusted gross income.

The reason Farley as well as PolitiFact use “adjusted gross income” is because Romney’s taxes are based on adjusted gross income—the numbers are right off his tax returns.  This is another one of those apples to apples things. Hot Air makes the same mistake when it points out the corporate income tax rate of the top 1 percent should have been used because it was much higher than that of the top quintile. But the 7.7% corporate income tax for the top 1% is based on cash income, not adjusted gross. PolitiFact’s Lou Jacobson based all his rates on the adjusted gross, which is what he should have done.

My conservative counterpart's main complaint is centered around PolitiFact’s lack of consistency in using the effective tax rates. So I took a look at nine fairly recent PolitiFact rulings involving taxes paid to analyze just how they determined “effective tax rates,” what sources they used, and how they used them, and put them all in a table. There we may have a little more agreement. Stay tuned.