WASHINGTON (Reuters) - The fairness of the tax code is a raw nerve for many Americans and Mitt Romney hit it on Tuesday when he pegged his effective personal tax rate at close to 15 percent.
Considering the Republican presidential candidate’s vast fortune, estimated at up to $270 million, his 15 percent estimate to some seemed low, especially compared to the tax rates that many Americans presume they pay, with the ordinary income tax rate topping out at 35 percent.
A furor has followed that is tapping into widespread voter angst over the tax code and a sense that the wealthy enjoy tax advantages that are unavailable to everyone else.
“The public has been very solid in a number of polls saying we should end lower tax rates for the wealthy,” said Michael Dimock, associate director of Pew Research Center, which conducted a study in December finding a rising number of Americans believe the tax system is rigged to favor the rich.
A factor possibly contributing to this perception is that the tax rate on much investment income has dropped over recent decades from 40 percent to 15 percent.
Very wealthy people like Romney tend to get most of their income from investments, not from a paycheck like average Americans.
Democrats are pouncing on Romney’s remark, with the Democratic National Committee accusing him of “taking advantage of loopholes in the current law” and “playing by a different set of rules,” than working Americans.
The fairness debate will flare again later this year when Congress weighs whether to extend the Bush tax cuts - and with them the 15 percent tax on investment income.
TAX REFORM A LONG-TERM PROJECT
Addressing the “fair share” issue - as the White House terms it - is a long-term project. With elections 10 months away limiting Washington’s ability to maneuver, it is clearly beyond the ability of the present Congress, but it may happen in 2013.
That is when some analysts expect a meaningful effort to overhaul the tax code, a politically risk-filled feat that has not been achieved since 1986, when Republican President Ronald Reagan forged a deal with congressional Democrats.
Reagan agreed to raise the top capital gains rate to 28 percent from 20 percent in a grand bargain. Before that, the capital gains tax rate had largely moved in step with the income tax rate, until the late 1970s when it started to trend down.
Since the Reagan reform of 1986, the tax code has become riddled with loopholes that enable a privileged few to avoid taxes, while the Bush tax cuts were a deliberate policy choice favoring investment income over wage income.
Romney made his fortune at private equity firm Bain Capital. His money is tied up in a bewildering array of investment funds, many with links to Bain and many in low-tax havens such as Bermuda, the Cayman Islands, Hong Kong and Ireland.
Most of his income comes in the form of capital gains, dividends and other investments. This is generally taxed at 15 percent today, while ordinary wage income is taxed by brackets going from zero for the first few thousand dollars of income, rising to 15, 25, 28, 33 and 35 percent in increments.
“The thing that will be interesting is what, if anything, Governor Romney says in terms of justifying or explaining the rate of tax that he is paying,” said Alan Viard, economist at the conservative leaning American Enterprise Institute, who backs a lower rate for investments.
Americans might not be on the same page as Romney is.
Fifty-seven percent of 1,500 adults polled by Pew agreed with the statement, “wealthy people don’t pay their fair share,” up from 51 percent in March 2003. One striking finding was that most Americans said they were not overpaying their own taxes.
In fact, the U.S. tax system is largely progressive, meaning the more you earn, the more you pay in taxes — on average.
But the ultra rich - those who get the bulk of their income from capital gains and other investment income - can pay less than those in middle-class categories.
“In fact, rich people do pay more taxes than those with lower income,” said Howard Gleckman, a resident fellow at the centrist Tax Policy Institute.
The caveat: “Except if you are one of those people who makes most of their money from capital gains; then you pay a very lower tax rate.”
Those making $1 million or more annually pay an average effective individual income tax rate of about 19 percent, compared with an average of 10 percent for those making between $100,000 and $200,000, according to the Tax Policy Center.
But an analysis by the nonpartisan Congressional Research Service last month breaks it down further, finding wide variation within income groups.
That report finds that the average tax rate among millionaires is around 30 percent, but the devil is in the variation. One quarter of the millionaire set pay a lower rate than 10 percent of those in the under $100,000 group, according to the CRS.
One tax meant to make sure the wealthiest pay some federal taxes — the Alternative Minimum Tax — has been a failure, by most accounts.
The AMT winds up hitting the upper middle class while skirting the wealthiest. It now hits 4 million Americans, largely those who make between $100,000 and $300,000, requiring them to often file two sets of returns to compute their taxes.
Several bipartisan tax overhaul plans propose bringing the ordinary and capital income rates closer together. The presidentially appointed Simpson-Bowles commission plan raises the capital gains rate to match ordinary income, for example.
President Obama wants to boost the capital gains tax rate to 20 percent for individuals making more than $200,000.
Romney wants to eliminate the capital gains taxes altogether for those earning less $200,000 and keep the 15 percent rate for those earning more.
Conservatives support a lower capital gains rate because they say the income is already taxed at the corporate level and that a steeper rate could deter investment.
“Our economy cannot afford a raise in the capital gains tax rates because it is a primary driver of investment in the economy,” Tax Foundation economist David Logan said.
This view - largely backed by Republicans in Congress - will lead to a showdown when lawmakers finally get around to revamping the tax code.
The business community is ramping up a lobbying effort to prevent the rate from rising to 20 percent at the end of the year - the figure to which it reverts if Congress doesn’t act.
Additional reporting by Patrick Temple-West; Editing by Howard Goller and Cynthia Osterman