What GOP returns teach us about taxing the rich

Earnest Hemingway: I am getting to know the rich.

Mary Colum: I think you’ll find the only difference between the rich and other people is that the rich have more money.

It turns out that when it comes to taxes, at least, Ms. Colum, was mostly—but not entirely–right. To see why, let’s take a quick trip through the tax returns of Newt Gingrich, Mitt Romney and their spouses. 

Admit it: Peeking at a celebrity’s tax return is more than a little voyeuristic.  But get beyond the sheer prurience of the exercise and the Romney and Gingrich returns tell us a lot about the way those with incomes of $1 million or more are taxed, and how they structure their lives to minimize taxes. But mostly, they tell us that all those who make $1 million-a-year are not alike. And most of them are surprisingly like the rest of us, only more so.  

Gingrich is typical. He made more than $3 million in 2010—mostly through distributions from an S Corporation. This allowed him to avoid double-taxation (since the S Corp is a pass-through entity that pays no tax). He also used this device to reduce his Medicare payroll tax.

But of his $3.1 million in income, only about $35,000 came from investments, and the rest was taxed at ordinary income rates—much of it at the top rate of 35 percent. It is no wonder that he paid close to $1 million in income taxes–an effective rate of about 32 percent.

Despite the rhetoric coming from President Obama and the claims of Buffett and others, that is not at all unusual.  Of the slightly more than 400,000 households making $1 million-plus, the vast majority make most of their income from wages or distributions from pass-throughs, and not from investments. Think entrepreneurs, doctors, lawyers, movie stars, and professional athletes.

As my Tax Policy Center colleague Bob Williams has noted in TaxVox, even among those in the more rarified top 0.1 percent of the earnings distribution (households making at least $2.5 million) fewer than 15 percent make more than two-thirds of their money from investments. Perhaps surprisingly, more than half make less than 10 percent.  

In 2011, those making $1 million or more paid an average effective income tax rate of about 19 percent of total cash income. If you want to compare the tax they pay to their adjusted gross income (the smaller amount that appears on a tax return), it would be closer to 24 percent.

Then there is that small subset of those whose principal occupation is investing. That’s Buffett. And that was Romney, at least before he took up presidential politics.

Of the $21,646,507 Romney reported on his 1040, $20,792,324 was investment income. And most was taxed at the 15 percent rate reserved for most dividends and long-term capital gains. Romney also gave away almost $3 million in charitable gifts (big contributions such as this are common—through hardly universal– among those making that kind of money). As a result, his effective income tax rate was a Buffett-like 13.8 percent.

Romney’s returns paint a picture of a man who was enormously successful in his business career (good for him) and who has, with the help of lawyers and accountants, carefully structured his income in a way that minimizes his tax liability. The result: a 203-page return and a very low effective tax rate.

If that offends you, don’t blame Romney. Blame the politicians who created this mess of a tax code. And remember that despite what Buffett and Obama say– and you might think–many high-income people do pay a bigger share of their income in taxes than their secretaries.