By Kevin Drawbaugh
WASHINGTON (Reuters) - Living off your investments is a much better deal tax-wise in the United States than living off of a paycheck, as Mitt Romney's 2011 tax return underscored on Friday.
Days after a secret video showed him scorning the almost 47 percent of Americans who pay no federal income taxes, the Republican presidential challenger disclosed that his 2011 federal tax bill was $1.9 million.
That is a lot of money by any standards, but on an effective basis, Romney's tax rate last year was 14.1 percent. That was much lower than President Barack Obama's, at 20.5 percent, and that of Romney's running mate, Paul Ryan, at 20 percent.
The main reason: Both Obama and his wife, Michelle, and Ryan and his wife, Janna, got about half of their 2011 income from wages. Not so for Romney and his wife, Ann.
The Romneys' 2011 tax return showed adjusted gross income of $13.7 million: $3 million from taxable interest; $3.6 million from dividends; $6.8 million from capital gains; and the balance from other sources. Their wage income? Zero. That largely explains their low effective tax rate compared with that of the Obamas.
Why? The United States over the past 30 years has deliberately favored investment income over wage income, which is taxed at a top rate of 35 percent. In a combination of trickle-down economic theory and raw political power, U.S. investors have won preferred tax-code treatment.
That code has not been fully overhauled in 26 years. In that time, many interest groups have loaded it down with loopholes, exemptions, credits and other complexities, each with political allies determined to protect it. Some of those tax breaks benefit the poor and the middle class, and some the wealthy.
TAXES AND THE ELECTION
The outcome of the November 6 presidential election will go a long way toward deciding if a thorough tax code overhaul will be attempted in years ahead and, if so, what it will look like.
Take carried interest, for instance, a major source of income for Romney.
One of the wealthiest Americans ever to run for the White House, the former Massachusetts governor built a fortune buying and selling companies at Bain Capital as a private equity financier. Those lucrative years gave Romney a tax advantage.
His campaign said in January he got $13 million in income over the last two years from "carried interest," a form of earnings available under the tax code to private equity partners and some hedge fund managers.
The returns show that Romney still has an interest in funds through Bain Capital. The Ann D. Romney Blind Trust lists a long list of Bain-related transactions, for example.
Carried interest is taxed at the 15 percent investment income-tax rate, not the higher ordinary tax rate.
Private equity partners say that is appropriate because there are risks involved in their work. Critics say carried interest is actually closely comparable to wage income.
Obama has proposed curbing the carried interest tax break and taxing these gains at the ordinary income rate, while Romney's position on the issue is still unclear.
Romney's effective tax rate is lower than many high-income wage earners "because of the 15 percent rate on dividends and capital gains and also the fact that much of that income likely comes from carried interest," said Duke University tax law professor Lawrence Zelenak.
The 2011 returns show the Romneys' effective tax rate would have been just over 10 percent if they had taken the full charitable-giving deductions to which they were entitled.
Effective tax rates vary wildly from person to person due to the code's complexity. But counting all U.S. taxpayers, the average income tax rate is 11.8 percent, according to the Tax Foundation, a think tank in Washington, citing Internal Revenue Service data for 2010.
In 2011, about 46 percent of Americans paid no federal income tax, most of them because they were poor or elderly, according to the Tax Policy Center, another think tank.
Almost two-thirds of those who paid no federal income tax did pay federal employment taxes that support the Social Security pension system and the Medicare health program.
Romney's 2011 return also shows a web of investments stretching from the United States to tax-haven jurisdictions such as the Cayman Islands, Luxembourg and the Netherlands.
"This doesn't strike me as a tax situation you'd want to be in if you're running for president - to have pages and pages of these foreign investments. There are many mysteries to these returns," said Zelenak.
(Additional reporting by Kim Dixon and Patrick Temple-West; Editing by Peter Cooney)