A Taxing Debate for Investors

01/23/2012 2:20 pm EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The controversy over Mitt Romney’s returns is a reminder that dividends and capital gains are likely to be taxed more as of next year—as they should, writes MoneyShow.com senior editor Igor Greenwald.

Thanks to the expensively inept Romney campaign, tomorrow is Tax Day.

April 16 remains the IRS deadline for filing 2011 returns. But Tuesday is when the recent Republican frontrunner will belatedly publicize his 2010 tax return as well as last year’s preliminary numbers.

The former private-equity tycoon has set tongues wagging by estimating that he pays a 15% tax rate—lower than most of the working stiffs Bain & Co. laid off under his tenure. Romney’s already described the $374,000 earned from speaking fees since 2010 as “not very much,” causing Jon Stewart to mock-gag on currency.

Now he’s due to reveal how much he earned from his invested fortune and any other sidelines. And hours later, President Obama will give a State of the Union address stressing fairness and advocating higher taxes for the very rich.

You just can’t buy the kind of advertising that Romney’s disclosures will provide. Mr. 15% has become a poster boy for the most indefensibly regressive features of the tax code.

Contrast his rate with the 31.5% paid by Newt Gingrich, the former House Speaker and Romney’s surging pursuer in the primaries. Sure, Gingrich may have chiseled Internal Revenue by taking too much of his income out as profit, thus possibly underpaying Medicare taxes.

But the rate gap still brings up the question of why Romney’s income from investments deserves to be taxed at half the rate paid by his main rival. It’s a question for Gingrich too, since the former House speaker would cut capital gains taxes to nothing, further lowering Romney’s tax bill.

The usual excuses don’t hold up. Higher taxes on capital gains and dividends don’t impair “capital formation” as opponents claim—witness Romney’s fortune and, more to the point, the one his dad accumulated under a much less friendly tax regime.

Capital formation was certainly not impaired under the 28%-plus capital gains rate that prevailed during the 1990s bull market. Nor has it been a problem of late. The housing bubble, like the bond bubble today, was a case of too much capital chasing a limited pool of assets.

There is an investment deficit out there, when it comes to corporate investment in domestic jobs, and it’s a product, in part, of the policies that tax labor so much more heavily than capital. This effective surcharge on jobs depresses projected returns on the investments that would create them.

It’s pointless to create jobs if the sales to support them won’t be there, and the sales won’t be there so long as the tax code favors the investment income from dividend-paying stocks over what’s earned from wages—and is much likelier to be spent.

The lower capital gains rate also drives companies to gamble on stock buybacks to produce tax-advantaged capital gains, often creating more debt and leaving less for productive investment.

If the Bush tax cuts expire as scheduled at year’s end, in the absence of a bipartisan political compromise, the capital gains rate would rise to 20% (18% for investments led at least five years), while dividends would be taxed as regular income, up to 39.6% at rates that prevailed before the sunsetting tax cuts.

At the same time, Obama is likely to argue tomorrow that lower taxes on labor, as proposed in his blocked jobs bill from last fall, are exactly what’s needed to spur job growth. There are few easy ways to pay for such breaks without running up the deficit even more, but asking guys like Romney to pay at least as high a tax rate as the maid who makes his bed is a slam dunk.

The burden is on the ex-governor to explain why that’s not the case. His tax returns are a good departure point for this discussion.

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