Should We Knock Down Romney's Fence?

Why Mitt Romney Is Paying More Than Enough in Taxes

"There exists . . . a certain institution or law; let us say, for the sake of simplicity, a fence or gate erected across a road." So wrote G. K. Chesterton in a 1929 piece recently excerpted in The Wall Street Journal. "The more modern type of reformer goes gaily up to it and says, 'I don't see the use of this; let us clear it away.' To which the more intelligent type of reformer will do well to answer: 'If you don't see the use of it, I certainly won't let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.' "

This brings us to Mitt Romney's tax returns.

Romney says he pays about 15 percent in federal taxes. Received opinion suggests we all ought to be just horrified by this. After all, even billionaire investor Warren Buffett professes to be dismayed that because (like Romney) he makes a lot of money in the stock market, and the tax rate on capital gains is lower than the tax rate on ordinary income, he pays a smaller slice of his income in taxes than employees who make much less.

Romney, on the other hand, doesn't want to raise the capital-gains tax rate. Left-wingers think this is laughable on its face. But is it?

If you've been hanging out at a protest encampment for the past few months, then you might think the only reason for the disparate tax treatment is because Congress is a wholly owned subsidiary of Evil Rich Dudes, Inc. But there are other reasons that sound equally '" indeed more '" persuasive.

First, there is the problem of double taxation. A share of stock is simply a piece of a company. A stock's price goes up a little if a company is expected to make a little money and it goes up a lot if the company is expected to make a bundle. The future earnings of the company are thus built into the stock price. When you buy a stock, you are basically buying a piece of its earnings. But those earnings will be taxed as corporate income. (The top corporate income tax rate in the U.S. is 35 percent.) If the added value of the stock is taxed as well, then those earnings effectively are being taxed not once, but twice. That hardly seems fair.

Second problem: inflation. Let's say you bought a share of stock for $100 in 1995 and sold it in 2010 for $200. You cleared $100, right? Not really '" because a dollar in 2010 buys less than a dollar bought in 1995. (That's why people on Social Security get annual cost-of-living adjustments.) Because of inflation, in 2010 it took $143 to buy what $100 bought in 1995. So you really made only $57.

If you pay a 15 percent tax on the $100 face-value gain, then you are really paying $15 on an actual gain of $57, so your true tax rate is 26 percent.

The spread between 15 percent and 26 percent isn't huge, of course. But suppose you bought a stock in 1970, and sold it for double the price 30 years later. You actually would have lost money '" lots of it '" because what cost $100 in 1970 dollars cost $443 in 2010 dollars.

And there have been times when the results of inflation plus higher capital-gains tax rates have been terrible. For instance, according to one Federal Reserve analysis, the actual tax rate on investments in the Dow Jones Industrials index between 1972 and 1992 was a whopping 233 percent. In other words: Investors paid $233 in taxes for every $100 they made. That hardly seems fair, either.

Or at least it doesn't sound fair unless you're a soak-the-rich kind of guy and you want to "spread the wealth around." But this brings us to the third reason to keep capital gains tax rates reasonable: Investment serves many social functions that also spread the wealth around. Investing in stocks is a good way to plan for retirement, for instance. But such investment '" which is crucial to job creation '" is also risky. Lower capital-gains taxes help compensate people who take risks that benefit everyone else.

Not everybody finds these points persuasive (Buffett certainly doesn't seem to). But if you're going to tear down a fence, it helps to know why someone put it up in the first place.

A. Barton Hinkle is a columnist at the Richmond Times-Dispatch, where this article originally appeared.