The Right's Capital Gains Misdirection Campaign

January 26, 2012 5:03 pm ET — Jamison Foser

Continuing the right's desperate campaign to convince you that rich people who pay lower tax rates than bus drivers are, in fact, overtaxed, the Heritage Foundation's J.D. Foster argues that Mitt Romney's effective tax rate isn't really around 15 percent, but more like 50 percent. It's a deeply dishonest argument, designed to distract and confuse. Not surprisingly, then, it's quite popular among conservatives.

Foster's case for estimating Romney's tax rate at 50 percent is that before Romney received capital gains income, that income was "first earned by businesses, most likely corporations, which pay tax at 35 percent. So Romney paid his 15 percent only after the government had taken its 35 percent cut." Plus, Foster says, before Romney invested the money in the first place, "a good chunk of it, perhaps all, was taxed at the individual rate as wage or salary income." Basically, the argument is that Romney's capital gains income, or the funds that led to it, were previously taxed in other ways.

There are so many flaws with this argument that it's hard to know where to start. First, as Paul Krugman has noted, this isn't even true of much of Romney's income:

First, $13 million of the total was carried interest, which gets taxed like capital gains but is really just commissions that receive special treatment for no good reason. No profits taxes were paid on that income; right there, a minimally defensible tax code would have levied $2.6 million more in taxes on Romney.

Krugman also explains that in opposing corporate income taxes, conservatives argue "that these taxes don't really fall on stockholders, they fall mainly on workers and consumers," so they're trying to have it both ways in now arguing that corporate taxes fall on stockholders.

But the basic flaw with Foster's analysis is that he applies it only to capital gains income. If you're going to argue that Mitt Romney should get credit for all the taxes paid directly and indirectly by both Romney and corporations on money that eventually ends up in his bank account, you have to apply that analysis to other types of income, too. After all, for an autoworker to get paid, that means a company made money from selling a car, and that money came from someone who already paid taxes on it. And that person got their money from a company that got it from a customer who already paid taxes on it. And so on. That isn't the way we do things, of course, and it shouldn't be. But Foster wants to apply that approach to capital gains income — and only capital gains income — in order to mislead people about taxation of investments.

The other part of Foster's argument, that Romney should be credited for the taxes he originally paid on the money he invested, is even worse. Foster suggests Romney is the victim of 'double taxation,' but he's actually double-counting Romney's taxes. Here's how it works: Romney made money in 1996. He paid taxes on it. Let's say 35 percent, just for the sake of discussion. So, we'd say Romney paid a 35 percent tax rate in 1996. Then Romney used some of that money to buy stock. Now, say he sold the stock in 2010, and paid capital gains taxes on the profit he made, at a rate of 15 percent. Foster wants to again give Romney credit for the 35 percent taxes he paid in 1996 and conclude that Romney really paid 50 percent taxes on his capital gains in 2010. Nonsense. He paid 35 percent on his income in 1996 and 15 percent on other income in 2010. If we say he paid 50 percent on the capital gains income in 2010, we're double counting the taxes he paid in 1996. (And remember, that 15 percent capital gains tax applies only to the gain: If Romney invested $1,000 on which he had already paid income tax, then sold the stock for $1,500, he paid the 15 percent tax only on the $500 gain, which he had never previously paid any taxes on.)

Conservatives want you to think 'double taxation' of capital gains violates some sacrosanct principle against taxing the same dollar more than once. It doesn't. There are all kinds of ways in which a given dollar of income is taxed multiple times. You pay income tax on it, you pay payroll taxes on it, you pay sales tax when you use it to buy your kid a winter coat, you pay taxes on it when you buy a plane ticket or a television or a tank of gas. But when a rich guy makes $20 million in investment income, Heritage gets all worried about 'double taxation,' even though it isn't. Capital gains is income. It's money you didn't have before. It's right there in the word "gains." And, right now, it's income that's taxed at a low rate.

Foster and his ilk focus on 'double taxation' and on confusing people about how capital gains are taxed in order to distract them from much clearer, and more important, matters. We need money to meet collective priorities like national defense, schools, roads, Social Security and Medicare, and the rich — unlike the poor — can easily afford to pay more in taxes. All the sleight of hand in the world can't change the fact that we have a choice between raising taxes on people who make millions of dollars, cutting programs like Social Security, or raising taxes on teachers and bus drivers. J.D. Foster can quadruple-count Mitt Romney's tax burden if he wants, and he still won't convince people that our problem is that quarter-billionaires are overtaxed.