David Frum

01.17.12

The Right Way to Tax Mitt Romney

It is not an outrage that Mitt Romney pays a low capital gains tax.

Nobody is patriotically obliged to pay more tax than the law requires.

If the tax rate on long-term capital gains is 15%, and Mitt Romney derives his income in the form of long-term capital gains, then he has no obligation to pay more than 15%.

We wouldn’t ask a politician who had five children to omit the deductions for one or two of those dependents, on the grounds that he already has enough deductions.

We wouldn’t ask a politician who qualifies for veteran’s benefits to forgo those on the grounds that his salary should suffice.

Perhaps you think it’s wrong that capital gains are taxed more lightly? In that case, it would be just as wrong if a politician had $15,000 of gains as $15 million. But in fact, it’s not wrong. The lower tax rate for capital gains is good policy—a policy that the US has followed almost from the inception of the income tax, a policy followed by almost every other advanced economy on earth (including some that don’t tax capital gains at all).

Here’s why:

We want capital assets put to their highest and best use.

If Joe can run the company better than Jane, if Jill can make better use of the corner of Main and Elm than Jack, then we want to see ownership of that company or that corner transferred as expeditiously as possible to the higher and better user.

That’s why we encourage transparent and efficient markets for capital assets.

A capital gains tax is a tax on the transfer of control of assets. If that tax is set too high, it can discourage even the most glaringly urgent transfers of control. Under Joe’s management, the value of the company may rise 30%. But if the capital gains rate is set at 50%, then the transaction from Jane to Joe will not occur—and everybody will be worse off.

Is a light tax on the transfer from Jane to Joe unfair to other taxpayers?

It should not be. The underlying asset will have taxes assessed against it: corporate income taxes if it is a company, property taxes if it is a piece of land. Those taxes are paid the day before the transfer of ownership, and they continue to be paid the day after. A transfer of ownership transfers the obligation to pay the tax. But the amount of tax collection in the economy is not diminished by the transfer, and it’s difficult to justify why the occasion of transfer should trigger yet more taxes.

That said, there are problems with the capital gains system of the United States, and two seem especially pressing right now:

1) A light rate of capital gains is premised upon a well-functioning corporate income-tax system. The US corporate income tax system is anything but. Even very highly profitable companies often pay no tax at all. But it’s the corporate income tax system, not the capital gains rate, that is the problem here.

2) The person entitled to the lower capital gains rate is the owner of the capital asset. But the US financial industry benefits from rules that allow non-owners the same benefit as owners: This is the famous “carried interest rule.” It’s utterly unjustifiable. If you’re investing with other people’s money, what you are earning is income—and it should be taxed as such.

But the right response to those two problems is to ... fix those two problems ... not to cite those two systemic problems as justification for re-electing the president who also failed to fix them.