Romney tax returns likely to stoke debate over economic fairness

Reporting from Washington —  The release of Mitt Romney’s federal tax returns on Tuesday may not provide dramatic new insight into his finances, but it is sure to fuel the increasingly high-decibel debate about economic disparity and tax fairness that has overtaken this year’s presidential contest and repeatedly tripped up the Republican presidential hopeful.

The former Massachusetts governor has revealed in financial disclosure forms in the past that he is worth as much as $250 million, but he has never released tax returns that reveal how much money he makes each year – or how much he pays in taxes.

He agreed to make public his 2010 federal tax returns, and his estimates for 2011, after opponents on both the left and right charged that he was hiding his income and assets. The issue has dogged his campaign in recent weeks and contributed to his loss to Newt Gingrich in Saturday’s South Carolina primary.

“Tomorrow you will learn that Governor Romney pays millions in taxes each year, that he gives millions in charitable contributions and that his investments are reported and taxed in full compliance with U.S. tax law,” said Romney spokeswoman Andrea Saul. “Governor Romney has paid 100% of what he has owed.”

The longtime private-equity chieftain has already said he pays an effective tax rate of about 15% -- substantially lower than the top 35% marginal tax rate on wages and salaries. Experts say he benefits from a tax code that allows investors to keep more of their income than wage earners, particularly investors in the rarefied world of private equity.

The intense focus on Romney’s tax returns underscores how the very core of his candidacy – his experience leading a private equity firm – is also proving to be a liability in a political climate in which class issues have taken center stage.

Gingrich has been hammering Romney over his tenure at Bain Capital, while Democrats have taken to gleefully mocking the him as a modern-day Gordon Gekko, the high-flying financier portrayed in the movie “Wall Street.”

“For the average person, it raises the issue of why some of the wealthiest people in the world are taxed at some of the lowest rates we have,” said Joseph Bankman, a professor of tax law at Stanford Law School who has testified against the practice of how carried interest is taxed. “Here is someone who kind of personifies income inequality.”

Whether Romney actually pays less than the average American remains to be seen, as it’s unclear if the 15% he cited includes his entire federal tax burden. The average effective federal income tax rate for individuals is 9% -- though it climbs to 18% when payroll, corporate and estate taxes are factored in, according to the Tax Policy Center.

Romney’s returns are likely to show how much he has gained from paying only the lower capital gains rate on much of his income from Bain, the private equity firm he co-founded in the mid-1980s.

Attention is also likely to focus on so-called carried interest, the profits earned by private-equity managers that are taxed as capital gains, not wages – although experts note that Romney may not currently be enjoying that perk if he’s no longer receiving direct profits from Bain.

“We may not see anything from a carried interest standpoint,” said Steve Rosenthal, a visiting fellow at the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution. “That may have played itself out. He may have gotten hundreds of millions at low taxes, and is now simply making dividends or capital gains investments.”

The Romney returns are likely to spotlight the other, congressionally mandated tax advantages enjoyed by the rich to reduce their tax burdens, as well as how much of his wealth is tied up in funds based in low-tax jurisdictions overseas, including the Cayman Islands.

Saul said Romney’s overseas investments are not tax havens. “The Romneys’ investments in funds established in the Cayman Islands are taxed in the very same way they would be if those funds were established in the United States,” she said.

In addition, the documents will show how much money Romney gives to charities, including the Mormon Church, which expects its members to tithe 10% of their income.

A public perception that the wealthy don’t pay their fair share of taxes has risen in recent years. A Pew Research Center study last month found that 73% of Democrats and 57% of independents cited it as their top complaint about the federal tax system, along with 38% of Republicans.

The questions swirling around Romney’s finances have only furthered the debate.

“We’re learning that there are some really rich people who are not paying that much, and that’s the way the system is designed,” said Leonard E. Burman, a professor of public affairs at Syracuse University and former deputy assistant secretary for tax analysis at the the Treasury Department. “There is a question about what is the rationale for taxing capital gains at such a lower rate than other income.”

The policy has drawn criticism from the likes of billionaire investor Warren Buffett, who told Bloomberg Television on Monday that while he does not fault Romney for paying only what the law requires, the tax code should be changed.

“He makes his money the same way I make my money,” Buffett said. “He makes money by moving around big bucks, not by straining his back or going to work and cleaning toilets or whatever it may be. He makes it shoving around money.”

The tax returns are likely to put the focus of the Republican primary debate even more directly on Romney’s central pitch – that his experience at at Bain Capital gives him the experience to lead a nation desperately in need of economic growth.

On the stump, Romney touts the investments he led in big-growth companies such as Staples and the Sports Authority, which now have tens of thousands of employees. His opponents, including his GOP competitors, have portrayed him openly as a greedy Wall Street “financial engineer” who made huge profits even when workers at firms he acquired suffered.

A review of Romney’s record by the Los Angeles Times/Tribune Washington Bureau found a mixed record of job creation in acquired companies. For example, four of the top 10 firms acquired by Bain during the Romney years eventually went bankrupt. But the review found a clear record of enormous financial gain: Of the four firms that went bankrupt, three provided significant gains for Bain partners and investors.

The mechanics behind Romney’s low tax rate puts more scrutiny on an industry that has been built largely on a long-standing deduction for interest expenses, encouraging the use of debt rather than equity to purchase and transform private companies through heavily leveraged investments.

Private-equity executives have become among the most aggressive at tax avoidance. “There is a contagion of tax sheltering” in the private-equity industry, says Brad Badertscher, a professor at Notre Dame who has studied tax liabilities of private equity firms. “They are willing to take risks in tax avoidance that others avoid, either for reputational reasons or because they lack the sophistication to do it.”

Badertscher and other academic experts emphasize that the tax breaks taken by Bain and other private-equity firms are legal. The deduction for capital gains income was intended to encourage risk-taking that could benefit the overall economy.

Another expert in corporate taxation says that even management fees intended to be taxed as ordinary income are often converted by private-equity partners into capital gains so that they are taxed at a lower rate.

“Management fees typically consist of 2% of the private equity fund’s capital,” said Sonja Olhoft Rego, an associate professor at Indiana University. Theoretically, this fee is paid as compensation for management services and is considered as ordinary income for tax purposes. However, she said, her studies of the industry show that “management fee income is often converted from ordinary income to capital gain income” by making the fees contingent on profitability.