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A Tale of Two Loopholes: The President's Taxes and Mine

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President Obama recently released his 2011 tax return, showing an adjusted gross income (AGI) of $789,674 on which he paid federal income tax of $162,074, or 20.5 percent. The president noted that, like Warren Buffett, his secretary paid a slightly higher rate than he did.

I still haven't filed my tax return for 2011 -- like Mitt Romney, I have complex investments which usually keep me from filing until October (Mitt and I still have to pay what we owe in April, and are subject to penalties and interest if it turns out we didn't pay enough). My 2010 return, however, showed an AGI of $723,924, on which I paid $115,310, or 15.9 percent, in income tax. Thus, while the president had nearly $66,000 more in pre-tax income than me, his after-tax income was only $19,000 higher.

Occupy Wall Street has focused attention on the growing inequality in wealth between the top 1 percent and everyone else, a topic the president addressed in comparing his tax rate with his secretary's. But a comparison of the president's tax return with my own shows that growing wealth gaps are also occurring within the top 1 percent, and that our supposedly progressive tax system is making the problem worse.

Though my income was similar to the president's, I actually have more in common with Governor Romney. We are both the sons of successful businessmen who had our own lucrative careers in finance but now get almost all of our income from investments rather than labor. In 2010, my earned income from several part-time academic positions was 9 percent of my AGI, somewhat higher than Romney's 3 percent, while my single biggest source of income was capital gains, which accounted for 56 percent of my AGI, almost identical to Romney's 58 percent.

In short, Governor Romney and I are coupon-clippers (so named for the interest coupons attached to bonds back when they were pieces of paper instead of electronic bits). Our low tax rates -- Romney's was 13.9 percent in 2010 -- are due almost entirely to the fact that capital gains and certain dividends are subject to a maximum rate of 15 percent, as opposed to the top rate for labor income of 36 percent.

The president, by contrast, is a working man. Earned income from his presidential salary and book royalties accounted for over 100 percent of his AGI (he reported a loss on investments). But while he paid income tax at a higher rate than Romney or me, his rate of 20.5 percent was still low by middle class standards. Why?

The answer is simple: the president gave to charity $172,130, or almost 22 percent of his AGI. Since charitable donations are tax-deductible, these gifts lowered his taxes by around $60,000; without them, his tax rate would have been closer to 28 percent.

To be sure, Mitt and I also gave away substantial sums (14 percent and 9 percent of our AGIs, respectively). But since our marginal rates are lower, our benefit from tax deductions is lower, too, so eliminating our charitable deductions would have only raised my tax rate to about 19 percent and Mitt's to 16 percent.

If you've made it this far, your head may well be spinning from all the numbers and percentages. And that is an important part of my point: our tax system's mind-numbing complexity results in people with similar incomes paying wildly different amounts of tax, which is not only confusing but unfair and inefficient.

Paul Ryan, Republican Chairman of the House Budget Committee, has proposed a tax plan he claims will address this problem by lowering rates while closing "loopholes." Numerous commentators have complained that the plan fails to identify a single loophole that will be eliminated, but Ryan has been crystal clear about one thing: he doesn't think that a lower rate on investment income is a loophole. In fact, he has called for the complete elimination of taxes on investments.

If we assume that Congressman Ryan succeeded in eliminating every other deduction and exemption in the tax code, what would be the impact? Using rates laid out in Ryan's "roadmap", the president's taxes would have gone up by over $22,000, making him a poster child for Republican claims that by eliminating loopholes, tax reform will improve the progressivity of the tax system. Yet the Ryan plan would nearly eliminate the income tax burdens of Governor Romney and myself. Mitt's taxes would have declined by nearly 95 percent, to just over $184,000, while mine would have shrunk by over 97 percent, to a mere $3,300.

Republicans argue that taxes on investment income reduce the incentive for job creation. Leaving aside the critical question of whether there is any evidence that this is true, the fact is that everybody offers a rationale for why the particular loophole they favor (and benefit from) is absolutely critical for the proper functioning of society. Republicans are welcome to argue that investment income deserves preferential treatment, but claiming that this is not a loophole is ridiculous.

Moreover, if they want to make that argument, they should also admit that they are in favor of the growing inequality in wealth, because that is the natural consequence of their position. Under their plan, if President Obama earns $100,000 in book royalties, he gets to keep $75,000 after paying federal income tax, but if I earn $100,000 in dividends, I get to keep $100,000. So given two people with equal incomes, the one who gets more of it from prior investments -- who by definition is richer -- will find it easier to accumulate new wealth.

Personally, I think that deductions for charitable donations are more justifiable than lower rates for unearned income, but I have come around to thinking that we ought to rid the system of "tax expenditures" entirely; if Congress thinks something is in the public interest, they ought to transparently appropriate money to spend on it. But let's at least be clear that the low rate on investment income is a huge loophole which benefits a tiny fraction of our richest citizens, and widens the gap between them and everybody else.

Around the Web

The truth about Paul Ryan's tax plan | The Daily Caller

The Ryan Tax Plan Isn't a Plan - Forbes

Ryan's tax plan: $6.2 trillion short - The Washington Post

Ryan Tax Plan: Seven And A Half Things To Know