Tuesday, January 24, 2012

How Much Did Mitt Romney Pay in Social Security and Medicare Taxes?

Update: The New York Times was able to find approximately $710,000 in earned income over the two years below. Total FICA taxes paid: about $42,000 on income of $42 million.

Mitt Romney offered a partial snapshot of his vast personal fortune late Monday, disclosing income of $21.7 million in 2010 and $20.9 million last year — virtually all of it profits, dividends or interest from investments. 
None came from wages, the primary source of income for most Americans. Instead, Romney and his wife, Ann, collected millions in capital gains from a profusion of investments, as well as stock dividends and interest payments.
Social Security and Medicare are financed through the FICA (Federal Insurance Contributions Act) tax, which applies only to payroll income. All other forms of income -- the capital gains, interest and dividends referenced above -- are excluded.

If all income were included, as we argued for here, Romney would have paid $3.3 million in 2010 and $2.8 million in 2011.
Full returns available here.

From Talking Points Memo

And, By the Way, Romney Didn't Create Any Jobs

As we discussed in this post on economic stimulus and job creation, hiring people is radically different from creating new jobs. Matt Yglesias goes the extra mile and addresses that point in light of Mitt Romney's job creation record at Bain Capital.
Romney knows very well that he was primarily in the private equity and leveraged buyout industries, and chose very deliberately to emphasize instead Bain's relatively minor venture capital activities. That's because as a matter of affect, it sounds way better to be providing seed capital to new firms than to be adding debt to existing ones and attempting to restructure them to suck more money out of the underlying assets. But I do think it's worth emphasizing that if what you're interested in is the systematic impact on the economy and the labor market there's no particular reason to see venture capital as "creating" jobs while private equity "destroys" them. 
The venture capitalists behind the computer industry, for example, have destroyed many jobs in the typewriter manufacturing sector. They've decimated the ranks of America's type-setters and photographic chemical manufacturers. X-Acto Knives are still for sale, but the market for them has been badly hit by computer innovations. The Internet has been deadly for the encyclopedia industry. That doesn't mean that the pioneers of word processing or desktop publishing are bad people or that word processing has been bad for the American economy. It's simply that significant innovations have wide-ranging consequences for the world. Businesspeople create or manage businesses, but the kind of "job creation" that happens when your product turns out to be really appealing so you need to hire a bunch of people to make and sell it has nothing to do with the kind of "job creation" that increases the overall volume of employment in the economy. A lot of the attacks on private equity are unfair, but the story of Mitt Romney Job Creator doesn't make sense either. 
Even if it were true that Romney's investment in Staples was typical of his business career, the mere fact that a lot of people work at Staples tells us nothing about the systematic impact of Staples on the economy.
But we do know something about that impact.
Dunder Mifflin, the fictional regional paper company at the heart of [The Office], is facing an increasingly competitive marketplace. Like many smaller players, it just can't compete with the low prices charged by big-box rivals like Staples and Office Depot, and it seems to be constantly bleeding corporate customers that are focused on cutting costs themselves. 

Quill.com, an affiliate of Staples, now sells Dunder Mifflin copy paper.

Monday, January 23, 2012

What the Bain Gang Can Teach Us about Corporate Tax Reform

We need to kill the business interest deduction.

As we noted in our discussion about eliminating the mortgage interest deduction, interest has historically been tax deductible. In fact, it wasn't until 1986 that personal interest was not deductible -- thank you, astonishing growth in credit cards and personal debt -- though the mortgage interest deduction was preserved. 

But it's now time to think about whether business interest should be deductible at all, and one of the best arguments against it is courtesy of private equity concerns like Bain Capital.

First, though, how awesome is that picture.

Private equity is a bit of a catch-all term that includes things like venture capital (to get a company off the ground and running), mezzanine capital (providing additional capital to an existing company), and leverage buy-outs (see Gordon Gekko). 

When Romney has been talking about creating jobs, he's been talking about venture capital. When people talk about the companies killed by Bain Capital, they're talking about leveraged buy-outs.

In its simplest form, a leverage buy-out is a like a mortgage, where you use the asset you want to buy to secure the financing necessary to make the purchase. Josh Kosman explains to Mike Konzal:
JK: The whole industry started in the mid-to-late 1970s. The original leveraged buyout firms saw that there were no laws against companies taking out loans to finance their own sales, like a mortgage. So when a private equity firms buys a company and puts 20 percent down, and the company puts down 80 percent, the company is responsible for repaying that.
Now the tax angle is that the company can take the interest it pays on its loans off of taxes. That reduces the tax rate of companies after they are acquired in LBOs by about half. Banks, also realizing this tax effect, were willing to finance these deals. At the time, you could also depreciate the assets of the company you were buying — that’s not true today.
They saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same.
MK: So the business model is based on a capital structure and tax arbitrage?
JK: Yes. It’s a transfer of wealth as well. It’s taking the wealth of the company and transferring it to the private equity firm, as long as it can pay down its debt.  It think it is real - the very early firms targeted industries in predictable industries with reliable cash flows in which they by and large could handle this debt. As more went into this industry, it became very hard to speak to the original model. Now firms are taken over in very volatile industries. And they are taking on debts where they have to pay 15 times their cash flow over seven years — they are way over-levered.
MK: The most common argument for why Bain Capital and other private equity firms benefit the economy is that they are pursuing profits. They aren’t in the business of directly “creating jobs” or “benefitting society,” but those effects occur indirectly through the firms making as much money as they can.
But even here, “profits” — how they exist, where they come from, and how they are timed — have a crucial legal and regulatory function. A recent paper from the University of Chicago looking at private equity found that “a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value,” which is value that comes from taxpayers to private equity as a result of the tax code. Can you talk more about this?
JK: That sounds about right. If you took away this deduction, you’d still have takeovers, but you’d have a lot less leverage and the buyer would be forced to really improve the company in order to make profits. I think that would be a great thing.
If you look at the dividends stuff that private equity firms do, and Bain is one of the worst offenders, if you increase the short-term earnings of a company you then use those new earnings to borrow more money. That money goes right back to the private equity firm in dividends, making it quite a quick profit. More importantly, most companies can’t handle that debt load twice. Just as they are in a position to reduce debt, they are getting hit with maximum leverage again. It’s very hard for companies to take that hit twice. 
So leveraged buy-outs aren't about turnaround artists, people who take failing companies, re-organize  them and get them back on track. Instead, it's financial engineering, just taking advantage of the tax code. As James Surowiecki at the New Yorker notes,

The rewards can be extraordinary: when Romney was at Bain, it supposedly earned eighty-eight per cent a year for its investors. But piles of debt also increase the risk that companies will go bust.
[B]etween 2003 and 2007 private-equity funds took more than seventy billion dollars out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.
And the business interest deduction is exploited by other industries as well, most notably investment banking. When a bank raises money by selling more equity, it faces a couple of problems. The first is that the previous group of shareholders are generally not happy, as the percentage of their ownership of the bank has gone down. Secondly, when the bank pays dividends, those dividends are not tax deductible, which makes the company less profitable. 

Raising capital by issuing debt solves both those problems. Each shareholder's stake remains the same, and the disbursements to the bond holders get written off the taxes. This led to some of the banks, most notably Lehman Brothers, becoming grossly over-leveraged, by some estimates up to 44:1. This made Lehman Brothers a very profitable company when times were good, but almost insured that it would get pummeled in the (inevitable) event of an economic downturn.

But what does the leverage really mean? Let's walk though an example, using a somewhat higher leverage ratio of 50:1. 

At that ratio, you could put up $2 but would have $100 in purchasing power, with the remaining money being supplied by a bank. If you invested that in stock, and the stock's value went to $101, you'd have a return of 50% -- you initially put up $2, but now have $3. 

But leverage works the other way as well. If the value of the stock drops by 1% -- form $100 to $99 -- you've lost 50% of your equity. And if the stock drops another dollar, your finished. 

(For the sake of comparison, the Federal Reserve limits the leverage you can use to buy stock to 2:1 through Reg T. (although that ratio can increase to 3:1 once the purchase has settled. Still, not so bad.)

The business interest deduction certainly made sense some time ago, but the financial wizards have turned it into a real hazard. Getting rid of this tax break would't prevent leveraged buy-outs or raising capital through debt, but it would re-focus these efforts on making sure the companies themselves did well. Private equity firms, banks and other corporations would have more "skin in the game," and the tax disadvantage of raising capital through equity would disappear.

It's also worth remembering that, despite the crowing about corporate taxes, the percentage of pre-tax corporate income used to pay taxes has fallen dramatically over the last 50 years:

From Kevin Drum and the Federal Reserve of St. Louis.
And corporate tax as a percentage of all US tax revenue has fallen harder.

See page 68 of this 2010 Senate Committee on Finance report. And thank you,  Felix Salmon.
So if we're trying to get the deficit back under control, we should be looking seriously at making corporations pay their fair share as well. Eliminating the business interest deduction would be one step down that path. 

Friday, January 20, 2012

Paul Krugman, Kevin Drum & Capital Gains

The main reason the rich pay so little is that most of their income takes the form of capital gains, which are taxed at a maximum rate of 15 percent, far below the maximum on wages and salaries. So the question is whether capital gains — three-quarters of which go to the top 1 percent of the income distribution — warrant such special treatment. 
Defenders of low taxes on the rich mainly make two arguments: that low taxes on capital gains are a time-honored principle, and that they are needed to promote economic growth and job creation. Both claims are false. 
When you hear about the low, low taxes of people like Mr. Romney, what you need to know is that it wasn’t always thus — and the days when the superrich paid much higher taxes weren’t that long ago. Back in 1986, Ronald Reagan — yes, Ronald Reagan — signed a tax reform equalizing top rates on earned income and capital gains at 28 percent. The rate rose further, to more than 29 percent, during Bill Clinton’s first term. 
Low capital gains taxes date only from 1997, when Mr. Clinton struck a deal with Republicans in Congress in which he cut taxes on the rich in return for creation of the Children’s Health Insurance Program. And today’s ultralow rates — the lowest since the days of Herbert Hoover — date only from 2003, when former President George W. Bush rammed both a tax cut on capital gains and a tax cut on dividends through Congress, something he achieved by exploiting the illusion of triumph in Iraq. 
Correspondingly, the low-tax status of the very rich is also a recent development. During Mr. Clinton’s first term, the top 400 taxpayers paid close to 30 percent of their income in federal taxes, and even after his tax deal they paid substantially more than they have since the 2003 cut. 

So it's a good time to get a little wonky and ask why capital gains and carried interest are taxed at only 15 percent, while ordinary labor income is taxed at rates as high as 35 percent. If you're the cynical sort, you think the answer is simple: Rich people make lots of their money via capital gains and carried interest, and the Republican Party is dedicated to making the lives of rich people easy and prosperous. So they've made sure those tax rates are low. 
Maybe so. But there's an official, noncynical answer too: Capital gains are profits from investments, and a high level of investment is good for the economy. Low tax rates on capital gains encourage investment and therefore benefit the entire economy.
But is this true? If it were, you'd expect to see some kind of long-term correlation between capital gains rates and the total amount of capital gains income. The lower the rates, the more the income. Let's roll the tape:

Do you see a correlation? I don't. What you see is two things. First, when people know rates are about to go up, they sell their assets quickly to beat the tax man and take advantage of the current rates. You can see that in 1968 and 1986. Second, capital gains skyrocket during investment booms. You can see that during the dot-com bubble of the late '90s and the housing bubble of the aughts. When you remove those artifacts, there's pretty much nothing left. No matter what the tax rate is, the level of capital gains pokes along at about the same rate. 
As the Congressional Research Service concluded in a study a couple of years ago, capital gains tax cuts "are unlikely to have much effect on the long-term level of output or the path to the long-run level of output (i.e., economic growth)."
So what about carried interest? What's that all about? Carried interest is a feature of the way partnerships are taxed, and private equity funds are essentially partnerships. In a partnership, it's frequently the case that one person puts up the money and another person manages the business. Both partners get equity in the enterprise: The former gets ordinary, garden variety equity and the latter gets "sweat equity." When the enterprise is sold off (hopefully at a profit), both are taxed at capital gains rates. 
Bain Capital acted as a managing partner in most of its transactions, so this was a pretty good deal for them. After all, most of us who work as managers, even if our pay comes in the form of a bonus that's based on the profitability of the company, have to pay ordinary income tax rates. That's because this kind of work is known as "labor." But if you manage a private equity fund, that exact same kind of work is defined as sweat equity and gets taxed at capital gains rates. 
This is pretty hard to defend. If it walks like a duck and quacks like a duck, it's a duck. Except in this one case, where it's sweat equity. There's really not much justification for it. 
So this is where we end up. Mitt Romney pays low tax rates on his capital gains because this is supposed to encourage him to invest his money. But it turns out that it doesn't. And he pays low tax rates on his carried interest because his job of managing companies that other people own was conveniently redefined as sweat equity and therefore treated as capital gains. It's a nice deal for the rich, who get nearly all of the benefit of these policies, but neither of them is really defensible. It's one thing for Mitt Romney to have gotten wealthy running Bain Capital. Good for him. But he ought to pay the same taxes on his earnings as the rest of us.
Oh, and none of these earnings are subject to taxation for Social Security. And if the capital gains come from stocks and bonds (except for those purchased in initial offerings), they're not coming from investments, they're coming from gambling.

Thursday, January 19, 2012

Good News, For a Change

It's beginning to look like we might be turning the economy around.

From Steve Benen at Political Animal:
The general trend on initial unemployment claims over the last two months has been largely encouraging, though there have been setbacks. Last week, for example, was a step in the wrong direction.  
This week’s report, however, was a very pleasant surprise. Initial claims not only dropped sharply, they fell to a level unseen in nearly four years. 
The number of Americans who filed requests for jobless benefits sank by 52,000 last week to 352,000, the lowest level since April 2008, the U.S. Labor Department said Thursday. Claims from two weeks ago were revised up to 402,000 from 399,000. Economists surveyed by MarketWatch had projected claims would fall to a seasonally adjusted 375,000 in the week ended Jan. 14. The average of new claims over the past four weeks, meanwhile, dropped by a much smaller 3,500 to 379,000.
In terms of metrics, keep in mind, when these jobless claims fall below the 400,000 threshold, it’s considered evidence of an improving jobs landscape. When the number drops below 370,000, it suggests jobs are actually being created rather quickly.
Steve also provides this chart tracking initial unemployment claims, and that arrow around 2009 is when Obama's stimulus package began spending money.

The Republicans have been slamming Obama's job creation record lately -- Romney has claimed that Obama has lost 2 million jobs, and Gingrich has been calling him a "food stamp president". (Bonus fun fact: Bush II had more people go on food stamps, about a half million more.)

But this graph shows quite clearly that Obama stemmed a horrific rise in initial unemployment claims, and has been -- slowly -- adding jobs ever since.

Another way to look at this would be to consider total (non-farm) employment, as Krugman did with this chart from FRED (the St. Louis Fed's wonderful collection of economic data. Jobs continue to tank once Obama took office, but once his stimulus plan was passed and dollars started moving out the door, things turned around.

Now, if the stimulus would have been bigger, the economy would have bounced back more quickly (and we still have quite a ways to go). But it's pretty hard to argue that Obama didn't stop the economic downturn and put us back on the right path.

Saturday, January 14, 2012

Median Household Income -- What Could Have Been

Paul Krugman points to a Lane Kenworthy post which includes this graph:

Krugman's notes that:
You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.
But Krugman omits this even more telling chart.
Kenworthy explains:

The dashed line in the ... chart shows what median income would have looked like had it risen in sync with per capita GDP. The difference is huge: in 2007, the median family’s income would have been $91,000 instead of $61,000.
Alan Kreuger, Obama's Chairman of the Council of Economic Advisers, noted much the same in a speech at the Center for American Progress earlier this week. From 1947 to 1979, each quintile performed about the same, with the lowest quintile actually performing the best. (All charts are from Kreuger's speech, and are generally based on Census Bureau and CBO data).

But from 1979 to the present, something(s) went very much awry.

And we note that the lowest quintile actually lost ground. Kreuger doesn't really address the causes for this, although he notes several possibilities, including changes in technology, decline in union participation and changes to the tax code.

But look what happens when a Democratic president gets elected.

Everybody does better. The bottom 80% of household perform at or near their historic averages, and the top 20% just cranks.

And if the median household income had continued to rise at it did during the Clinton years, it would now be at about $59,000, instead of about $50,000.

 But we do know where the money went.

As Kreuger notes:
Because of these trends, the very top income earners have pulled much further ahead of everyone else. The following chart shows the share of all income earned by the top 1 percent and 0.1 percent of households.

Not since the Roaring Twenties has the share of income going to the very top reached such high levels. 
The magnitude of these shifts is mind-boggling. The share of all income accruing to the top 1% increased by 13.5 percentage points from 1979 to 2007. This is the equivalent of shifting $1.1 trillion of annual income to the top 1 percent of families
A trillion dollar shift. Annually. To the 1%.

Friday, January 6, 2012

Banks are Evil: Special "Citibank Must Die a Thousand Deaths, Its Wives and Children Scattered to the Corners of the Earth, Its Orchards Burned and Its Fields Plowed with Salt" Edition

... or Return of the Float.

Back in the old days, banks needed a float for check deposits. The float was the time it took your bank to process your check, send it to another bank, and actually get the cash (OK, a wire) to post to your account. If memory serves, local checks typically took three days, and out-of-state took five.

This meant that the banks ended up with several days where they got the use of your money for free.

Technology improved, check clearing went digital and now the float has been reduced to about a day.

But getting money for free is something banks really, really like, and Citibank came up with an ingenious way to do it in the mortgage field. As Felix Salmon reports:
Most salaried Americans ... get paid every two weeks. Which means, to all intents and purposes, that you need to be able to make one mortgage payments out of every two paychecks.
And that in turn raises an intriguing possibility: if you take half of your mortgage payment out of every paycheck, you’re going to end up making 13 mortgage payments a year. Which will pay down your mortgage faster, and could save you thousands of dollars
Enter the ever-helpful Citibank, with a product which does just that. It’s called The BiWeekly Advantage Plan®, and it’s essentially an automated mortgage payment, of half your monthly mortgage payment, which comes out of your account every two weeks. Easy.
Except that:
 Payments are remitted to your mortgage company monthly.
As Felix notes:
The payments are made in arrears, of course. You make your half-payment, and then wait two weeks, and you make your second half-payment, and then the two are bundled up and sent off to the mortgage company (which in nearly all cases is CitiMortgage itself) as a single monthly payment.
Which means that for roughly half the year, Citibank is sitting on an amount of money equal to half your mortgage payment. That money has left your account: it’s not yours any more, and Citi can do with it as it pleases. And Citi gets the float from all that money until it gets around to sending it off to pay off the mortgage.
Basically, Citi is getting a big advantage from you making half your mortgage payment two weeks early.
It gets better. Citibank actually charges you to lend them money for free.
There is a one-time non-refundable enrollment fee of $375 and a transaction fee of $1.50 for each draft [or $39 a year]. 
Pure friggin' evil. It's their best idea since:

Tuesday, January 3, 2012

Capital Gains and Crappy Tax Policy

Recently, the Congressional Research Service published a study on changes in income distribution from 1996 to 2006, which shows, first of all, that's its good to be rich.

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

While the bottom twenty percent actually made less money in 2006 than ten years earlier, the wealthiest top 0.1% saw their pre-tax income nearly double. During that time, the average inflation-adjusted after-tax income went up 25%, but the only people who did that well were in the top 20%. The other 80% of America under-performed.

Why is that?

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

One big reason is capital gains (and dividends). The share of income derived from these sources actually went down for the bottom 80%, amounting to little more than an rounding error, while capital gains and dividends ended up contributing more than half of all income to the top 0.1%.

In fact, the "changes in capital gains and dividends was the largest contributor to the increase in the overall [measure of inequality, or] Gini coefficient."

From Wikipedia:  While developed European nations and Canada tend to have Gini indices between 0.24 and 0.36, the United States' and Mexico's Gini indices are both above 0.40, indicating that the United States (according to the US Census Bureau) and Mexico have greater inequality.

Tax policy played a roll as well. From the CRS study:
The major tax change between 1996 and 2006 was enactment of the 2001 and 2003 Bush tax cuts, which reduced taxes especially for higher-income tax filers. These tax cuts involved reduced tax rates, the introduction of the 10% tax bracket (which reduced taxes for all taxpayers), reduced the tax rates on long-term capital gains and qualified dividends, and other changes. 
In 1996, long-term capital gains were taxed at 28% (15% for lower-income taxpayers) and all dividends were taxed as ordinary income. By 2006, long-term capital gains and qualified dividends were taxed at 15% (5% for lower-income taxpayers).
So we basically cut a tax rate in half for the people who needed it the least. The bottom 80%, remember, only derived 0.7% of their income from capital gains and dividends, while the top 0.1% got a majority of their money from unearned income. 

As the CRS notes:
Tax policy changes that affect progressivity will affect after-tax income inequality. Duh.
What all this means is that the effective tax rate for the top 0.1% plummeted; they paid out nearly 33% of their income in taxes in 1996, but only 25% in 2006. This is what the Bush tax cuts did.
From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

Fortunately, though, the Bush tax cuts ushered in an era of unknown economic growth.

From here.
Or not.

But the Bush tax cuts are the largest contributor to the the increase in the national deficit.

From the New York Times.
So, in summary, if you want to reduce the deficit, improve income equality and maybe remove the jackboot of capitalism from the trachea of the bottom 20% of Americans, all without affecting the economic performance of the country, start taxing capital gains as ordinary income now.

Bonus: Taxing capital gains also fixes Social Security!