Presidential hopeful Mitt Romney last week released summary information about his 2010 tax return. From my perspective, its a great jumping off point to explicate several financial literacy basics. In this post I’ll deal with tax and in the next capital.
1)On the income side Mr. Romney’s return showed $20,000,000 in income, most of which was capital gains income. There was also approx. $500,000 in speaking fees or earned income (a relative term and potentially misleading.)
2)On the deduction side he showed charitable contributions of $4,000,000 and other common and not unusual deductions for state income taxes, home real estate taxes, etc.
I’m going to try to keep this simple so bare with me. Income on capital/property transactions is treated differently from earned income under U.S. tax law. For that matter income on different property types is taxed differently from each other.
Capital is another word for property and under our tax law virtually every type and sub-category of property (there are 100s) has its own rules specific to that property/capital. Examples of property types are real estate, stock, bonds, insurance and intangibles. Under each property type there are numerous sub-categories, example real estate; commercial rental, residential rental, home residence, etc. Example intangibles; copyrights, trademarks, patents etc.
Historically, tax rates on property and earned income have been all over the map, check out the rates from 1913- 2013, sometimes they’ve run together, other times one is higher than the other (1). Capital gains (2) rates, however, usually have been the same or lower than the earned income rates. Currently the top rate for capital gains is 15% while the top rate for earned income is 35%. Now cap gains is only one flavor of tax attribute and nowhere near the full story but I think you get the point, it’s detailed and property specific. In fact the rights of property ownership have evolved over 1000’s of years, and are in and of themselves complicated and by no means universal. This inherent complexity is further complicated by a U.S. Tax Code which has been used and will continue to be used to promote various and often competing social and growth agendas. The lower rates typically associated with capital gains are there to promote economic growth. Since capital is scarce it’s competitive and seeks the highest returns (income less tax). If all else is equal that means it can and will go anywhere in the world.
To be continued……………
(1) Regardless of individual tax rate fluctuations total tax receipts relative to the GDP has averaged around 18% since World War II with little variation. See details here.
(2) Capital gain [selling price less cost] on a sale of an enumerated property type [not all types qualify] held for at least a minimum period of time.