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Is the capital gains rate right?

By Kay Bell ·
Thursday, January 19, 2012
Posted: 3 pm ET

Here's the latest big non-news item: Mitt Romney is very, very rich. Like a quarter of a billion dollars rich.

Usually when the topic of wealth comes up, folks are interested in how a person made his or her money. But in Romney's case, at least for us tax geeks, the focus is on how much tax he pays on his money.

That leads to our next bit of non-news: not very much. The Republican presidential front-runner says his tax rate is "around 15 percent." We'll get more specifics when Romney releases his tax returns, something he now says he'll do once he's got the GOP nomination in hand.

It's no surprise that rich people have accountants who help them find ways, legal of course, to reduce their tax bills. But Romney's tax advisers didn't have to work that hard.

Most of Romney's vast wealth comes via investments. And the capital gains tax on investment earnings is in most cases a maximum 15 percent.

Now there's nothing wrong with Romney taking advantage of that low rate. That 15 percent top capital gains tax rate applies to every investor, whether as rich as the former Massachusetts governor or someone making $50,000 and who has just a few shares of a stock.

The difference, which Romney's opponents are quick to point out, is that that Average Joe making 50 grand per year likely faces a tax rate 10 percentage points higher than Romney's 15 percent tax rate.

Joe's ordinary income falls squarely in the 25 percent tax bracket for the 2011 tax year. Of course, if Joe gets any earnings from his stock or sells it, he, like Romney, will owe just 15 percent on the earnings or sale profit. But that amount of lower-taxed income is not the bulk of his IRS bill. Joe pays 25 percent on the money he gets from his job.

There are good reasons to reward investors with lower tax rates. People who put money into ventures they believe in and expect (hope) will grow and help out the overall United States economy should be rewarded.

And the lower capital gains tax rate is one of the few instances in which saving and investing rather than spending is rewarded by the tax code.

But is the 15 percent rate appropriate?

The tax rate on investment earnings had been 20 percent until George W. Bush got his tax cuts enacted. And the 15 percent capital gains tax rate is in effect, thanks to a deal between President Barack Obama and Congress in December 2010, through the end of the 2012 tax year.

The capital gains rates (there's an even lower one, 0 percent right now, for folks in the 10 percent and 15 percent tax brackets) are set to head up a bit in 2013. Whether than happens depends in large part on the November election results.

But regardless of what happens at the polls, it's a discussion that's worth having now.

Do you benefit tax-wise from investment earnings? Do you think the current capital gains rate is too low?

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January 27, 2012 at 2:55 am

If Average Joe make $50,000 per year, would only pay a maximum effective rate of 12.5% if single. As Kevin points out, the tax system is progressive, and Joe will get at least one exemption of $3,700 plus the standard deduction of $5,800 for a single person. Because of this, his total taxable income is only $41,500. The tax on that $6,256 (according to the IRS tax table), which is 12.512% of $50,000. If Joe sets aside any money in an IRA or 401k, that's all tax free too, further reducing his effective rate.

It is completely dishonest and misleading to say that he would pay 25%, and stating "that is for illustrative purposes only" doesn't cut it. You can't use a completely incorrect figure to make it look like Romney pays less than the average tax payer, and then just say "oh, well that's just for illustrative purposes." If it's to illustrate a point, it has to be accurate.

January 23, 2012 at 12:59 pm

Thank you, Kevin, for pointing out actual math rather than emotional responses, and thank you Kay for acknowledging the oversight.

I think another point frequently missed is that the capital gains rate is usually only applied for investments longer than 1 year (not including dividends, which are generally a small percentage of gains in a given year). This allows "invested" money to work through the financial system for at least 1 year, if not more. If the gain is made from "quick profit" (which many people purport, but is actually very hard to do in the market), it is taxed as ordinary income, and subject to the same rules as earned income. I might have missed something, but to the best of my understanding, this is the case.

January 22, 2012 at 7:37 am

since when becoming succesful in this country become a bad thing?
I am a small buisiness owner who worked two jobs to save my money and risk my savings and home to make my dream become a reallity! What people fail to realize is that money has been taxed many times before paying capitol gains of "only" 15% as many in the media are reporting.I am not wealthy but i am doing ok, dont need a bailout but i earn a profit for my work, risk, investment, if i fail should i get a bailout? no! but if i succeed i should make a profit, have you ever seen a poor person creat a job? A politician manufacture a product or any government agency do anything effieciently?If people dont invest and take risk the economy will never grow! WAKE UP!

Ed Mc Guire
January 21, 2012 at 10:44 pm

The article also implied that Romney is not paying enough on his $750 Million, giving the impression that is what he earned each year. No one pays income tax on their "wealth" only on the increase or profit for the tax year. If "average joe" also had $750 Million buried in the back yard he would not pay any income tax unless or until he invested the money and made some profit on it, i.e., capital gain, interest, etc. We use the income tax code for lots of reasons to drive financial activity by the populace. I remember when there was no income tax on earned interest. Also whebn there were no IRA's or 401(k)'s. If Romney must pay more on capital gains how come average joe isn't paying this year on his IRA or 401k earnings? You know it also wouldn't be important if Warren Buffet's secretary was paying a higher rate than him if he would just loosen up and pay her a better salary to start with. Anybody with a buck is a target for everyone that wants a piece of the action without working for it.

January 21, 2012 at 5:08 pm

This seems to be an attack on Romney and others that have made money, saved it and are now living off of it. And some are trying to make the case that the rate is too low. On the other hand there are 67,000,000 that are not paying tax at all. That's somewhere north of 20% of all taxpayers. Just because he didn't spend all of the money he made and is now living off of his investments does that mean he is a 'bad guy'. Not in my book

January 20, 2012 at 9:20 pm

I think the point that lower tax will encourage people to save and invest more was a bait. Or a lubricant, to help the average Americans to swallow the fact that it disproportionately benefits the rich. Individuals receiving 6 figure income or more from investments and/or as interest do not need that encouragement.

There is no argument I can think of that would show progressive rate on capital gains/dividends/interest as not fair.

Yet those with most to lose will fight to keep that loophole open.

January 20, 2012 at 9:18 am

A longer look at our progressive tax rate system can be found in this Bankrate Tax Basics article:

Kay Bell
January 20, 2012 at 12:05 am

Kevin, you are correct that because of the progressive nature of the tax code a person's income is taxed at several levels. My example was for illustrative purposes and I should have made that clearer.

January 19, 2012 at 10:28 pm

This article is misleading and dishonest. Average Joe making $50k per year does NOT pay 25% in taxes. He only pays 25% on what is earned in that tax bracket. Overall, he's paying 17.25% BEFORE standard deductions, etc. If you're going to criticize the tax code, at least honestly apply it to the scenario. Breaking this down:

$0-$8500 10% Taxes $850
$8501 - $34500 %15 Taxes $3899.85
$34501 - $50000 %25 Taxes $3874.75
Total taxes $8624.60 (17.25%) of $50,000 income IF single.

If you want people to save and invest less, you tax it more. If you want people to save and invest more, you tax it less.