Romney's 15% average income tax rate is all over the news, with the usual "tax the rich" outrage.
Romney pays little income tax because, hold on...Romney has little income. The guy doesn't work. He lives on his investments and campaigns for President. If I took a year off of teaching to go on a round-the-world gliding tour, I wouldn't have much income either, and would pay little income tax.
(We're all guessing here, of course -- maybe it's all crafty shelters. But who cares about Romney anyway; the issue at stake is whether the US should substantially raise rates on everyone else's interest, dividends, capital gains, or wealth itself, in addition to estate and property taxes.)
Yes, from an economic perspective, interest, dividends and capital gains are not "income." Romney should pay taxes, and at least at the same rate as everyone else. He should pay taxes on his consumption, not the returns on his investments.
A central proposition in the economics of optimal taxation is that the tax rate on capital should be zero or close to it. Like anything else in economics, there is a huge literature of ifs ands and buts, yet the result seems fairly robust. (Google "optimal taxation of capital." This is not a political statement, there are thousands of pages of equations behind it. There is a separate "optimal taxation" literature on "optimal redistribution," with some equally surprising results that I'll write about some other day.)
Intuitively, this is related to the theorem that you shouldn't tax intermediate goods, or have tariffs for moving goods around the country. Romney's income was taxed once, when he made it. It's not efficient to tax it again, because he chose to save it rather than spend it immediately on an orgy of houses, private jets, and a big vacation for his extended family.
If you made money in dollars, paid taxes, then went to Canada and got $1.20 Canadian, it would make no sense to say "you made 20 cents of income, we'll tax it." It makes no more sense to pay taxes again on money that is moved over time. We decry that Americans don't save enough, the Chinese, the trade deficit and so on. Well, if you want people to save more, stop taxing it.
For this reason, the U.S. Tax code has been slowly reducing the taxation of rates of return. Capital gains and dividends are now taxed less than ordinary income. IRAs, 401(k), 526, and a welter of other devices allow people to save and invest without paying taxes on the rates of return. (It would be much simpler to just eliminate taxes on rates of return, but then the lawyers and accountants would have nothing to do.) Dividends are finally taxed at the same rate as capital gains. Estate taxes have been slowly and chaotically lowered.
Taxes on capital and wealth also are singularly unproductive of income, and very productive of tax shelters.
It's been a slow and painful process. And now, about to be undone, for no good economic reason.
Obviously, economists need to communicate better. Economists in general need to keep reminding everyone to look at tax rates, distortions and incentives first and foremost, not taxes. Opinion writiers like Paul Krugman's post on the subject don't do the world a favor by deliberately forgetting this basic principle when it is politically convenient.
