Explaining Southern California's economy

Mitt Romney's taxes are a masterpiece of wealth management

GOP Presidential Candidates Debate In Myrtle Beach

Joe Raedle/Getty Images

MYRTLE BEACH, SC - JANUARY 16: Republican Presidential candidates, former Massachusetts Gov. Mitt Romney (L) and former U.S. House Speaker Newt Gingrich (R-GA) share a laugh during a Fox News, Wall Street Journal-sponsored debate at the Myrtle Beach Convention Center, on January 16, 2012 in Myrtle Beach, South Carolina. Voters in South Carolina will head to the polls on January 21st. to vote in the Republican primary election to pick their choice for U.S. presidential candidate. (Photo by Joe Raedle/Getty Images)

Mitt Romney released his 2010 and 2011 tax returns today, revealing that he is, as we already knew, R-I-C-H. What's eye-popping — and what explains why Romney has been reluctant throughout his political career to provide a window into his finances — is how low his federal taxes are, relatively to people who make their money on "earned income," such as wages and salaries.

The numbers are large. In 2010, Romney made $21.6 million on 2010 and paid $3 million in federal taxes, and effective rate of just 13.9 percent. In 2011, he reported making $20.9 million in 2011 and expects to pay an effective rate of 15.4 percent.

If it's any consolation to people who routinely pay taxes the mid-20-percent bracket, the Romneys overpaid in 2010, to the tune of $1.6 million. Time for a new accountant, Mitt!

Businessweek digs into the numbers and focuses on what provides a fairly large portion of the Romneys incomes: "carried interest" treated as capital gains rather than earned income and taxed at 15 percent:

The discussion of Romney’s returns has reignited the political debate over the tax treatment of investments and particularly carried interest, or the profits stake that private-equity managers receive from successful investments even if they don’t invest their own money. It is taxed at capital gains rates, and President Barack Obama and many Democrats want to reverse that policy, calling it unfair.

Romney’s 2010 income included $7.4 million in carried interest, said Ben Ginsberg, national counsel for the campaign. Romney, who touts his track record in investing in companies such as Staples Inc. and The Sports Authority Inc., received $5.5 million in carried interest in 2011.

During 2010 and 2011, Romney paid $7.5 million less in taxes than he would have if various Obama tax plans were implemented, including letting the tax cuts enacted in 2001 and 2003 expire and taxing carried interest as ordinary income, said Seth Hanlon, director of fiscal reform for the Center for American Progress Action Fund, a Washington research group often aligned with Democrats.

Do the math. In 2010, Romney made $21.6 million, almost all of it in capital gains, with 34 percent coming from carried interest — income that critics of carried interest, a fixture of the hedge-fund and private-equity compensation worlds, believe should be classified as regular income and taxed accordingly.

Romney hasn't worked for Bain Capital, the private-equity firm that is the source of his riches, since 1999. But for more than a decade now, he's continued to earn millions from his relationship with the firm. His 2010 tax return shows massive income from carried interest. It's safe to assume that his returns from the rest of the 2000s would show a similar percentage of carried interest income, although in the down years of 2008 and 2009, it might not have been quite a higher on the dollar-value front.

Capital gains are one thing. There's an argument that income invested has already been taxed once and that it shouldn't be taxed again, at least not at the same rate. Some also argue that cap gains are needed for ongoing productive investment. Why tie that money up in government when the "job creators" can use it to spur the economy? Some of this reasoning has held sway: cap gains rates have been steadily decreased from their historic levels of about 30 percent.

But carried interest is something else, and you can see why Romney doesn't necessarily want to talk about it. It's effectively a huge tax break for the financier class. Even some financiers are horrified by it.

That said, everything about Romney's taxes show that he has done a masterful job of setting up a financial future for himself and his family that will protect as much wealth as possible from the greedy hands of government. The money he makes is sheltered as cap gains, and the money he makes that he wants to pass on to his children is tucked away in trusts that protect them from paying gift and estate taxes, as Businessweek notes.

You might not really like that Romney can protect so much of his income from earned-income tax rates. But you have to admire his financial sophistication. And maybe even copy some of it. You don't have to be Romney rich, after all, to generate more income from capital gains and eventually have your investment income outpace your regular income. It's not a bad retirement strategy — even if you don't plan on retiring at the White House.

Depending on who wins the presidential race in November and what the Congress looks like, it could get even better for the wealthy. Many Republicans, including Romney and Newt Gingrich, advocate curtailing or eliminating the capital gains tax. 

No word on carried interest, however. But we'll undoubtedly hear more about this special category of income in the months ahead.

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