ataxingmatter

Tax Questions about the Romney-Ryan Ticket--from Romney's Tax Returns to Ryan's Vouchercare

As the election approaches, I find myself asking what concerns me most about the Romney-Ryan ticket.  There's a lot.

1. Rommey's disparaging comment about "the 47%".

Romney treated the vulnerable elderly, those still unemployed who were left jobless by Bush's "Great Recession", and the vast majority of the bottom three quintiles of the income distribution for which the standard deduction and personal exemption are INTENDED to ensure they don't have to pay an income tax as though they were all deadbeats who had not sense of personal responsibility and just wanted a government handout.  Remember that the income tax is just one piece of the federal tax system--payroll taxes take a significant bite out of low income taxpayers' income, and they usually have state income taxes and sales taxes (which are highly regressive) as well.  Romney's disdain for this group--and his assumption that he needn't bother to think about them--augers ill for the future of a Romney-Ryan administration.  We would take a significant step closer to rule by oligarchs, if we put oligarchs into the presidency who don't even recognize how their wealth and status has been achieved at the cost of ordinary folk.

2. Romney's refusal to release additional tax returns

Romney has simply stonewalled on information of direct relevance to a Romney presidency.  This is bad for two reasons. 

First, it suggests that he would serve as president with the same arrogant view of himself as the one who decides what the people need to know and the same arrogant notion that he got where he did on his own "merit" rather than on the foundation of years of wealth, prestige and status with a large helping of government support for his father's industry (roads are built free of charge to auto manufacturers, and what should be their primary competitors--public passenger railroads--are starved by the GOP in Congress to the point that they can't keep schedules because of being shoved aside by the freight owners of the rails they run on). 

Second, it suggests that there is likely information in those returns that would reflect poorly on him as president.  Even more use of offshore tax havens?  More questionable use of trusts to hide who owns what or where it is?  Failure to report offshore financial assets (that could be the basis for a criminal charge) until participation in the "voluntary disclosure initiative"?  

How can we expect a Romney-Ryan administration to deal appropriately with the obscene "carried interest" provision when he is ashamed of revealing the returns that benefitted him and his donors so magnificently from it?  How can we expect a Romney-Ryan administration to take the fair stand taken by President Reagan's administration on capital gains taxes--in the 1986 reform act under Reagan, the preferential rate that has benefitted Romney and Ryan so enormously and given them much of their wealth was eliminated!

This willingness to stonewall around relevant information and the potential that the information that isn't being disclosed would at least reflect poorly on him suggests that as president he would similarly engage.  Would Romney be another Bush who pushed for preemptive war in Iraq without adequate planning, without regard to the long-term costs, without regard even for a just rationale because of his willingness to railroad everyone to adopt the neo-con approach of loving warfare?  Romney's type of secrecy could easily allow for manipulation of public information to the extent that we are led down another blinder-gate like the Iraq war.

3.  Romney and Ryan's various positions on privatization and/or reduction of benefits under social safety net programs like Social Security and Medicare and Medicaid.

Ryan has made no bones about where he stands--he condemns earned-benefit programs, likely because he never expects to need them (and, after all, Congress has had marvelous health care for itself all these years).  Romney has waffled as he has with every policy, depending on the audience and the stakes, but his core "market fundamentalism" (as revealed by item 1) makes clear where he really stands--privatization and voucherization and benefit cutbacks and program decimation for programs like Medicaid (under the guise of "federalism") would be the future under a Romney-Ryan administration.  Our economy cannot be sustained that way.

4. Attitudes towards inequality, lack of progressivity in the tax system.

One of the most worrisome aspects of a Romney-Ryan presidency would be the lack of concern about the growth of inequality in this country and its disastrous impact on broad-based economic growth and a sustainable democracy.  The far-right GOP from which Ryan springs and which supported Romney's candidacy extols market fundamentalism above all else, celebrates wealth no matter how acquired or at what cost to society, and disregards the decline in the middle class that has been a direct result of the dominance of market fundamentalist policies over the last four decades.  Deregulation, privatization, militarization, the celebration of greed and tax cuts for the wealthy and big corporations are the cornerstones of the new right-wing consensus. 

Those are also the policies that gave us the financialization of the economy, the decimation of U.S.-based manufacturing through our subsidizing of the movement of active businesses offshore, and ultimately the Great Recession and the loss to ordinary Americans of most of their savings represented by the value of their homes.  Bush and his Treasury secretary Paulson took measures to save the big banks, but they didn't put the kinds of conditions on those savings measures that would have gone a long way to ameliorating the impact of the Great Recession--such as requiring clawbacks of mortgage loans in bankruptcy and other measures to prevent the foreclosure crisis that has driven honest, hardworking Americans from their homes. 

 Romney-Ryan and the far-right political machine funded by Sheldon Adelson, Charles and David Koch and their one-percenter peers will simply reinstate the Bush tax-cuts-for-the-rich and damn-the-rest policies.  Under Romney-Ryan, we can expect elimination of the estate tax, which will increase the budget deficit while adding to the enormous inequality gap and allowing multibillionaires to pass their wealth to heirs who do nothing to earn it free of any tax ever (most such estates haven't been taxed on their appreciation during the lifetimes of the decedent, and won't be taxed on death, and won't be taxed to the beneficiary either).  We can expect elimination of any taxes on income from capital, so that the oligarchs will bear none of the tax burden on their primary source of income.  Spending on public infrastructure and safety net programs will cease (as military spending continues to expand to fund the oligarchs who own the military-industrial complex).  Progressive tax rates, which have been steadily reduced to a flatter structure, will likely disappear, replaced by a regressive VAT or by a flat structure that puts more of the tax burden on the middle and lower income groups and much much less on the oligarchs.  Corporate taxes will continue to decrease, as a way of rewarding the multinationals who fund GOP political power and the oligarchs who manage and own the corporate giants.  Wages of workers will accordingly continue to languish.  Corporatism and class warfare will win the day, and ordinary Americans will bear the brunt of it.

This is not a pretty picture.  It is the reason I find the Romney-Ryan ticket such a worrisome prospect for our future.

Growing inequality calls for both "predistribution" and (rightly directed) redistribution

In putting forward my theme of democratic egalitarianism, I have often noted that there is no such thing as an economically egalitarian society--there will always be differentials among people, those differences often relate to social class and the education, privileged upbringing, and networking connections that ensure success for some and deny success to others as well as to innate abilities, so that those differences inevitably translate into some being better off economically than others.   

Because of those differences, the "powers that be"--i.e., existing concentrations of financial assets, prestige and associated political power among the privileged class at the very top of the income and wealth distribution-- result in redistribution upwards from poor and middle class to the upper crust.  And most in that privileged upper-crust think they've acquired it all on the basis of their own merit and that the reason others don't have it is because they are irresponsible, don't work hard enough, don't have a good business sense or are just incompetent. 

(That is of course the tale told by the like of Mitt Romney at his private fundraiser in Flordia, where he revealed his utter disdain for half of the US population and his self-indulging belief that he got where he is entirely on his own merit .  He can't even see, much less acknowledge, either his silver-spoon upbringing of class, wealth and connections or the various government-subsidized upwards redistribution from which he has benefited through capital gains preferences, carried interest treatment, disregard of the harm caused by his leveraged-buyout business model, and government subsidies through high-value government contracts and low-cost government loans.) 

Therefore, I have argued,  democratic institutions (government, programs, policies) must target achieving a sustainable economy that provides a decent livelihood for all.  They must also prevent inordinate inequality, because huge inequality among the citizenry foils all attempts to achieve either a sustainable economy or sustainable democratic institutions. 

That means that government policies must focus on creating paths for redistribution downwards from the upper crust to the middle and lower classes, undoing the corporatist top-down approach that has supported class warfare and allowed the wealthy to capture most of the productivity gains since Reagan's presidency.  Two government systems can work, on the margins, to achieve some level of downwards redistribution--benefits and taxes.  Benefits do so by providing a safety net under those most vulnerable who have never achieved a sustainable economic livelihood--the unemployed and unemployable, the sick, the elderly, the children who have poor schools, poor families, and inadequate shelter, nutrition and opportunity.  Taxes do so by taking more from those who have grabbed an inordinate portion of the resource pie and using those revenues to fund benefits as well as infrastructure (human and physical) that supports the efforts by ordinary Americans to achieve sustainable livelihoods.

We have been moving backwards on both of these systems.  The radical right has spent the last 30-40 years pushing an agenda that ultimately wants to (i) dismantle or radically reduce benefits programs (voucherizing medicare, privatizing social security, cutting back on unemployment, allowing states to reduce medicaid and children's health coverage, etc.) and (ii) eliminate taxes on corporations and the primary source of income of high-wealth individuals through a gradual reduction in progressive rate structure, elimination of the estate tax, elimination of capital gains taxes (and treatment of wealthy people's wages as though they were capital gains, through provisions like stock options and carried interest).  Paul Ryan's positions on Medicare and Social Security should be a clarion-call to get out the vote--against the Romney-Ryan ticket-- of every person who does not earn more than $300,000 a year.   The Norquist-Koch Brothers-Karl Rove-Ryan-Romney agenda on taxes should similarly cause ordinary Americans who earn less than $300,000 a year to take to the streets and to refuse to vote for any member of the GOP.  Recall that the beginning of the current trend towards too little tax revenues and especially too little taxation of the ultra rich was radical reduction of rates with purported base-broadening (such as elimination of the capital gains preference, creation and then ramping up of the alternative minimum tax).  As could be expected, lower rates lived on (and were lowered even more by Bush) but much of the base broadening was short-lived:  lobbying by the privileged at the top led to a quick return to a capital gains preference and the undoing of the AMT as an inequality leveler.  The Bush tax cuts rewarded corporate owners and managers and the wealthy class with extraordinary tax relief, while imposing long-term deficits on the country, behind a cheerful facade of "tax simplification" that was irrelevant for the 70% of the population that uses the standard deduction.

There is a third leg to the reduction-of-inequality stool.  Tax reform that restores a truly progressive income tax is one leg.  Benefit reform that builds on the achievements of the New Deal rather than destroying them is another.  The third leg is what some call "predistribution"--paying attention to the means by which the uppercrust has seized all of the productivity gains and reduced the ability of everyone else to have a decent, sustainable livelihood. 

British Labour leader Ed Miliband has called for predistribution as a new agenda in Britain.  See Predistribution: A Big New Idea, Noted, The Nation (Oct. 8, 2012), at 5. 

The term [predistribution] was coined by US political scientist Jacob Hacker, who in 2011 noted that discussions of government responses to inequality often begin and end with redistribution [downwards]--taxing the rich to provide benefits for the rest.  But that's only half the equation, Hacker said, uring progressives to pay more attention to 'the way in which the market distributes its rewards in the first place.' That includes regulations that protect consumers and empower workers: 'The regulation of markets to limit extremes and give the middle class more voice is hardly easy. ... But it is both more popular and more effective than after-the-fact mopping up.'

Milibrand agrees.  Noting the high human cost of austerity, he said, 'We need to care about predistribution as well as redistribution.' After trying 'to make work pay better by spending more on trasfer payments,' he argued, government must 'also make work pay better by making work itself pay.'

These concepts--predistribution (making up for malfunctioning markets to make work itself pay) and redistribution downwards (actual reallocation from market results through taxation and benefit policies)--are closely interrelated.  Successful redistribution downwards augments the ability of workers to afford necessities and small luxuries, and that economic activity empowers workers in the markets and gives workers an opportunity for a voice in the markets and workplaces compared to a position where employers and owners have almost dictatorial control and can garner all the workers' productivity gains for themselves.  Focus on predistribution, however, reminds us that worker rights are essential to a sustainable, broad-based economy

What kinds of rights are we talking about?  Surely a critical right is the workers' right to collective bargaining (supported by a "yes" vote on Proposal 2 in Michigan that would put that right in the state constitution where it could not be removed by the radical right legislative block).  Surely the right of the state to build infrastructure (that will create worker jobs) rather than allowing a wealthy tycoon to corner the market on international bridge crossings in Detroit and hog the revenues for himself rather than allow them to be earned by the people (Proposal 6, vote "no" so that Matty doesn't have veto power allowing him to co-opt public infrastructure for his private profits).

Predistribution pays attention to how much ordinary workers are paid compared to how much the managers at the top get out of a company.  We should be "pushing local employers to narrow the pay ratio between the top and the bottom ranks of their workforce."  Id.  For too long, we have acted like it is just fine for the "market" to demand that the wealthy be allowed to exploit communities and workers for their own benefit.  We need to say no.

Predistribution pays attention to regulations that protect workers--from worker safety to time off to family leave. It disregards the multinational corporations' pleas for laws to suit them and instead asks why we should be subsidizing their ability to move active business assets to foreign countries and leave US workers unemployed.  It acnkowledges that we have for too long allowed corporate owners and managers to snow us with their claims that "globalization" and "free trade" worked for our benefit, when in fact these are excuses for offshoring jobs so that the owners and managers can enjoy even higher "rent" profits.  As Milbrand says, "It's just not true that all the top CEOs will leave the country unless we pay them whatever they demand."  Id. 

Romney's Tax (Mis)Calculations: if your two and two don't add to four, pretend the laffer curve gives you more

Anybody watching last night's presidential debate surely became aware at some point that Romney's so-called "plan" for economic growth is an empty shell based on the idea that he's made money for himself so he knows how to run a country. 

Romney's plan is pure market fundamentalism--a mistaken view that the "market" will take care of all problems and vigorously grow to elevate everyone's livelihood just so long as government regulators stay out of the business of regulating and allow business owners and managers (particularly huge multinational corporate owners and managers) to do whatever they want, including fire workers, outsource business assets, and engage in complex schemes to turn tax laws into tax avoidance bonanzas.  Oh, and the government should provide all kinds of subsidies to aid those businesses at minimal or no (tax) cost--from interstate roadways to easy rights to exploit national lands owned by the public; from localo fire protection to federally funded international security; from state-based contract protection to federal courts that provide handy forum choices to the wealthy and big corporations; from state and local property tax exemptions and waivers to federal intellectual property rights that provide monopoly power and stifle innovation (exactly the opposite of the Founders' dream).

And when Romney claims that he can "simplify" the tax system and lower everyone's rates without increasing the deficit, reducing the taxes paid by the upper crust, or increasing the taxes paid by the middle class, while at the same time increasing the military budget and striking more threatening poses a la the Bush neo-cons on Iran?  That's gibberish, as many respected studies have shown.

So to his rescue comes one of those propaganda tanks in the guise of an intellectual "institute"--the Institute for Policy Innovation (IPI).  The Institute puts out a "Tax Bytes" newsletter/blogpost supporting right-wing, market fundamentalist, Friedman-lite tax policies.  Not surprisingly, the Institute is sanguine about making a Reagan-style across-the-board rate reduction program work even in an economy that is still in transition back from the brink that the Bush market fundamentalist tax and fiscal policies put us in.  That is,  in spite of the fact that Romney-Ryan stand for things like making the Bush tax cuts permanent, eliminating the estate tax, maintaining the preferential rate structure for capital gains and carried interest, and even extending that very low rate preference to all other capital income (like interest) for those earning less than $200,000 (who don't have much capital income to worry about though, since the vast majority of it goes to the people in the very top 5% who make millions, not thousands)--the Institute says "increased private sector growth" will make the plan work.  See "Of Course It Can Work", IPI, TaxBytes 9.25 (October 17, 2012).  That's just the Laffer Curve idea at its worst--the wacky concept that when you cut taxes, there will be more tax revenues because of all the wonderful things that a self-regulated market does for economies.     

So IPI thinks you can cut government revenues even more than Bush did (when the Bush tax cuts of 2001-2003-2004 (and the rest) amounted to about one-third of the cause of the Great Recession).  It buys into the fairy tale that has been used by the far right to justify obstructionist, non-realistic policy positions and that has created the fiscal debacle we are still climbing out of.  That fairy tale is the market fundamentalist "pie in the sky" concept that broad economic growth can be magically generated just by letting the rich continue to get richer even if the middle class is falling into poverty and infrastructure is crumbling. 

Romney shows he's a "know-it-all" who has no real ideas at all

I missed almost all of the first debate but watched most of this one.  My quick sum-up of the action was the Obama was straightforward, prepared, and much more energetic than in the first debate.  While I don't think he has been a great president, he has nonetheless acted on a number of matters in ways that move us away from the disastrous policies of the Bush years--fairer immigration actions, more interest in the middle class and jobs, wise action to save the auto industry when Romney would have allowed one of the midwest's major industries to rot on the vine, attempting to move the corporate tax debate away from giveaways for the multinationals and towards more reasonable tax policies, movement on health care reform (though still not towards the single-payer option that we must eventually embrace), movement on financial institution reform through Dodd-Frank (though still not sufficient control of the financialization of the economy).

Romney, quite frankly, came across as an arrogant shell who doesn't have any substance underneath the expensive coif of hair and Armani suit.  He constantly blames Obama for the Great Recession that stemmed directly from the failed Bush economic policies favored by the Republican party's right wing, the same policies that Romney and Ryan want to re-install if they take over the White House.  He consistently fails to acknowledge that the deficits under Obama were temporary ones caused by the trillions of dollars of unnecessary Bush individual and corporate tax cuts, the Bush preemptive wars, the class warfare of tax policies that favor the 1%, privatization of education and the militaryh, and the financialization of the economy egged on under Bush by the right's misguided views of "free" trade (meaning business can run over the workers and the environment at will and pay less taxes even while causing more societal harm).  Romney (as Obama noted in the debate tonight) goes George W. Bush even further--he would ruin Medicare by turning it into "voucher-care" that was insufficient to meet vulnerable seniors' needs, and he would destroy Social Security by privatizing it so that seniors are at the whim of the stock market and Wall Street traders for their very livelihood.

Yet this guy born with a silver spoon in his mouth and with a family of connections to power really thinks that he got where he is on his own!  What a laugh.  And then he thinks that he can bamboozle the American people by saying "I know how to do that" about creating jobs, getting rid of the deficit, creating growth, solving immigration, making us "energy dependent in 8 or 5 years" and everything else he can promise us.  But he doesn't think he has to bother to tell us anything about how he will do that.  Often when asked specific questions, he fell back on his "The last four years with Obama have been awful and I feel your pain" absurdity,   His claim of empathy with the ordinary folks asking questions in the audience was absurd because one only has to harken back to that tape of his disdain for the 47%--and his arrogant view that anyone in that group was dependent on government and unwilling to take personal responsibility for themselves--to know that he doesn't really give a damn about ordinary folk like those in the audience tonight.  He'd follow that with another claim that he would fix everything because "I know how to do that", yet in every instance there was nary a specific word about  exactly what he would do.  

 One thing is for sure--Romney's view that cutting tax rates across the board by 20% will jump-start the economy is "nonsense", as even conservative GOP economist Bruce Bartlett acknowledges.  See Bruce Bartlett, Romney's Tax Plan and Economic Growth, Economix Blog, New York Times (Oct. 16, 2012) (statng that "the idea that tax reform will jump-start an economy suffering from the after-effects of a cyclical downturn is nonsense" and concluding that "even if Mr. Romney’s plan is enacted as proposed the growth effect will be small to nonexistent").

On taxes, Romney now claims that he will not cut the amount of taxes paid by the top 5% but will give everybody else a tax cut.  Note that isn't the same that he has said for months on end, when he made clear that everybody would get the same 20% rate reduction (which would give the wealthy a huge dollar cut, and the middle class a piddling cut) and mocked Obama for wanting to hold the upper-crust more accountable for helping reduce the deficit.  He claims he'll not increase the deficit, even though he wants to cut taxes and eliminate the estate tax and increase military spending.  He won't say what deductions he'll cut or what protections for the poor he'll keep.  He claims the numbers add up but won't tell us what the numbers are.   I think it's perfectly clear:  he won't say how he can do that in a revenue-neutral way because it can't be done.  The New York Times editorial yesterday chimed into the growing list of reputable organizations asserting that his numbers simply don't add up, noting "the many deceptions in the campaign’s blue-sky promises of low taxes and instant growth."  See Editorial, Mitt Romney Needs a Working Calculator, New York Times (Oct. 15, 2012). 

[The Joint Committee on Taxation] asked its staff what would happen if Congress repealed the biggest tax deductions and loopholes and used the new revenue to lower tax rates. The staff started adding it up: end all itemized deductions, tax capital gains and dividends as ordinary income, and tax the interest on state and local bonds, along with several other revenue-raisers.

The answer came last week: ending all those deductions would only produce enough revenue to lower tax rates by 4 percent. 

Mitt Romney says he can lower tax rates by 20 percent and pay for it by ending deductions. The joint committee’s math makes it clear that that is impossible. Id.

Note that Romney doesn't intend to tax dividends and capital gains at the same ordinary income rate that us ordinary folks pay on our compensation income, so he wouldn't even get to a 4% reduction in rates with his version of tax "simplification."  He wants to keep allowing people like him to get a tax-advantaged "preferential rate" on carried interest that they get as their compensation in vulture capital "private equity" funds that buy up American businesses and load them with debt and offshore their jobs.  He wants to keep taxing capital gains and dividends at the ridiculously low rates achieved by the Bush tax cuts that were a major factor in driving us from surplus to deficit.  He even wants to cut capital gains and dividend and interest tax rates to zero for those making less than $200,000.  (Of course, that group doesn't have much of that kind of capital income--it is mostly the province of the very rich at the top.  One suspects the rate cut for the upper middle class that would apply to is just a prelude, like most of the Bush-era tax cuts, to a Republican push to eliminate taxes entirely on capital income, which Romney and Ryan have supported in the past.)  He wants to cut taxes for the huge multinational corporations and encourage them to continue moving our jobs offshore.

There is no way that such a tax policy makes sense for America.  It will let the rich get richer, when we are already at a point where the middle class is shrinking because of the way big business has grabbed all the productivity gains for the managers and owners and left ordinary workers hanging out to dry.

Reaganomics--with its push for privatization, tax cuts, militarization, and deregulation--stabbed at the heart of the US economy.  The Bush tax cuts drove us from surplus to deficit in one fell swoop and set the stage for the Republican obstructionist games that have gone on during the four years of the Obama administration, in which the radical right GOP has cared more about pushing for extremist policies beneficial to the wealthy and the big corporations they run rather than considering what is good for the country.  Romneyomics would be even worse--right-wing market fundamentalism at its most extreme, with the rich making off like bandits and the rest of us left to scramble for crumbs. Surely the American folk aren't going to buy this idea of rehashing the very ideas that got us into the Great Recession mess from the guy who says "I know how to run the country because I got rich as a vulture capitalist". 

Romney's Tax Returns--What We Do Know --Tax Avoidance (Part VII)

I've written a series of postings on what Romney's scanty release of tax information shows us about his wealth and his concern for his country.  The last of those was Romney's Tax Returns--What we do know (Part VI).  (interested readers can follow the links back through earlier parts, to see the various types of questions that are raised about his tax avoidance techniques and the potential issues that are likely to be lurking in the tax returns that he refuses to release, especially the 2008-2009 returns.)

Romney finally released his actual 2011 tax return, after having provided an estimated return at the time of the release of the main parts of his 2010 tax documents (but not of everything we would like to see connected with his federal tax status).  I will try to cover the additional information gleaned in posts through the end of this week, but readers may be interested in reading the Drucker article featured in Bloomberg today:  Jesse Drucker, Romney 'I Dig It' Trust Gives Heirs Triple Benefit, Bloomberg.com (Sept. 24, 2012).

It's worth reminding readers of Romney's derogatory comments at a May fundraiser in a wealthy donor's Florida home implying that those who don't pay federal income taxes (but do pay payroll and Medicare and sales and property and state and local income taxes) are freeloaders who mooch off of everyone because they think of themselves as victims.  See various postings on this "47%" topic, such as this one, this one, and this one.

It's also worth pointing out up front that the wealthy have many legal techniques for making high income while paying very little taxes (carried interest being one of them) and for passing along their wealth to their family without much payment of gift or estate taxes (the I DIG IT trust being one of them).  Congress can and should eliminate many of these tax avoidance techniques.  For example, Congress could eliminate the carried interest game (essentially a "Wall Street Rule" not incorporated in the Code) through very simple legislation making clear that managers of private equity funds and real estate partnerships and hedge funds shall treat all of their "profits interest" distributive shares as compensation income taxed at ordinary income rates like their secretaries, gardeners and nannies pay.  Congress could eliminate the various estate tax gambits with legislation to forbid the various kinds of trust games the rich play and the various kinds of "discounts" that they claim for self-created (and easily undone) restrictions on transferability of passed-along assets through S corps, family limited partnerships, and trusts.

Now, on to Romney's intentionally defective grantor trust (commonly called the "I DIG IT" trust). Here's what Drucker says:

He [Romney] has also enhanced his family’s wealth by moving assets worth $100 million into a trust while taking steps to avoid paying any gift taxes. The trust’s value isn’t counted in the $250 million that his campaign cites as Romney’s net worth.

... The return doesn’t show how much Romney paid for [the fund and other investment] holdings [added to the trust], nor the value assigned to them when he gave them to the trust, so it’s unclear how much in total the trust has saved in gift and estate taxes.

...The Obama administration estimates that closing the loophole Romney used would bring the gederal government almost $1 billion in the coming decade.  That's a 'laughable' under-estimate, said Stephen Breitstone.... A single billionaire could pay $500 million more in estate taxes if these trusts are shut down. ...

Romney or his trust received shares in DoubleClick eight months before the company went public in 1998.  The trust sold them less than a year after the IPO.  The trust's sale of the DuobleClck stake made it possible to save hundreds of thousands of dollars in estate and gift taxes.

Multimllionaires use such trusts to avoid those taxes in three ways.  First, they can assign a low value to assets they donate to the trust.  Second, when the trust sells assets at a profit, the donors can pay the relatively low capital gains taxes on behalf of the trust.  By doing so, they leave more money in the trust, untouched by the much higher gift tax.  Third, by paying those taxes, they can reduce the pile of wealth eventually subject to an estate tax when they die.  

***

Here's how they work: the person setting up the trust, like Romney, contributes assets such as an interest in a fund or shares in a company.  If he makes that contribution before those assets appreciate--particularly when they are privately held and difficult to value--he can claim the gift tax obligation is low or non-existent since the declared value is low or zero.  If the trust generates any income--such as by selling stock--the eventual tax bill is the responsibility of Romney, not the trust.  By paying the capital gains tax, which was 20 percent in the late 1990s [when Romney's trust was established] and is now 15 percent, he can avoid depleting the funds in the trust--in essence making an additional donation that's free of gift taxes.  That benefit in particular makes this type of trust 'a more powerful driver of wealth transfer in estate planning than almost anything else' said Breitstone. ... Id.

The defective grantor trust strategy was presented to Romney and Bain by a Boston lawyer at Robes & Gray as "a strategy for avoiding gift taxes by conservatively stating the value of assets put into a trust."  Id.  It was fairly common for such stakes related to profits interests to be valued at zero for figt tax purposes, though in 2005 there were proposed regulations that "discouraged the practice."  Id. 

Can Romney be faulted for taking advantage of this kind of trust to avoid taxes and pass along millions to his dynastic heirs tax free?  Surely all the wealthy people that he thinks of as his peers do so--more than 3 million U.S. trusts and estates had $91 billion of income in 2010.  Id.  But for someone who wants to be president, wouldn't you think he would have some sense of at least "noblesse oblige"--a duty to pay a little more than the measly 14% or so that he pays in taxes to the country he wants to boss (er....serve)?

Clearly Romney doesn't have any sense that wealthy people should be paying more.  He has indicated that part of his agenda as President would be to eliminate ANY gift and estate taxes, making it even more likely that America by 2040 will be a country of a plutocratic elite with enormous wealth living in protected communities of like-kind people and completely segregated from the overwhelming majority of ordinary Americans who earn their living with hard work that is actually taxed as hard work.

As for myself, I do think Romney can be faulted for using these trust techniques to preserve his family dynasty at the cost of the federal fisc.  But I don't think wealthy people like Romney care what ordinary people think about this issue (refer again to his comments about many Americans, above). 

But he has perhaps done us a service by running for President, because even with the scanty information he has released, we can see something of the way the ultra-rich avoid paying taxes.  As Breitstone says in the Drucker article, he "uses every trick in the book" and "It's going to be harder to do tax planning in the future [because] he's bringing attention to things that weren't getting attention."  Id.

Congress needs to act to eliminate these known types of shelters used by sophisticated wealthy taxpayers to get around the estate tax.   And let the rate go back up as it is slated to do at the end of the year.  Maybe if we get a saner Congress, Congress would even consider enacting a graduated rate that goes from 55% on the above-exemption amount to as high as 70% for those estates in the tens of billions.

 

 

Romney's Tax Views Lead to Blooper Comments Denigrating America's Elderly and Poor

Most of us who follow tax issues in the news and in political campaigns are aware that GOP candidate Mitt Romney has been very secretive about various items.

First and foremost, he has been secretive about his own extraordinary wealth:  he has refused to follow his father's example in releasing more than a decade of tax returns and he has maintained numerous accounts offshore, including in jurisdictions that are known for banking secrecy.  This secrecy is problematic for many voters, because without those returns it is difficult to evaluate his aggressiveness in using shelters or taking controversial positions on returns to save himself tax dollars --a topic that is surely relevant to his qualification to hold the highest executive office in the land.

Second, he has been secretive about his plans for achieving across-the-board tax cuts of enormous benefit to the uber-rich and multinational corporations while claiming to maintain revenue neutrality.  Respected non-partisan tax analysts have concluded that his plans simply don't add up--the "arithmetic", as Democratic speeches noted, is against him.  When he refuses to specify just what programs he would cut while cutting taxes and increasing military expenditures, many voters are naturally suspicious that the cuts will all be taken out of the safety net--voucherization of Medicare, privatization of education funding, and even more of the deregulation that cost us so much in the 2007-8 financial crisis--while continuing the over-spending on military and various lucrative loopholes for the wealthy like the "carried interest" provision for private equity managers.

Third, he has been secretive about his lack of commitment to the disadvantaged in our society.  His failure to describe how he will create jobs (other than through his claim that managing vulture capital "leveraged buy-out" funds is good preparation for the presidency) suggests that he has no ideas other than the long disproven ones being pushed by the Chamber of Commerce and other business lobbying organizations--less regulation, more privatization, more reductions to earned benefits like Medicare and Social Security, and more tax provisions that favor the rich that the GOP labels--without empirical support-- as the "job creators".  But he has nonetheless tried to foster an image of caring about American people who weren't born to the life of wealth and luxury that he's enjoyed.

That third point of secrecy was shattered by the revelation of a taped video of Romney comments to major donors (delivered at a May 17 fundraiser at an investment banker's home in Boca Raton, Florida), in which Romney showed utter disdain for the large segment of the US population who ultimately do not pay any federal income taxes.  Romney called those who pay no federal income tax "dependent on government" and indicated that they see themselves as "victims".  He concluded he'd "never convince them they should take personal responsibility and care for their lives."  See David Corn, Secret Video: Romney Tells Millionaire Donors What He REALLY Thinks of Obama Voters, Mother Jones (Sept. 17, 2012).

 

See also Chris Miles, Obama vs Romney Polls: How Latest Romney Gaffe May Have Just Lost Him Ohio, Policymic (Sept. 17, 2012);  MicCheck.com email alert, 47% Video Worsens Romney's September Nightmare (Sept. 18, 2012); Chris Cillizza, The Fix: Mitt Romney's darkest hour, Washington Post.com (Sept. 17, 2012).

Romney's 47% comment fairly drips with disdain and scorn for ordinary Americans, casting them, as the Mother Jones article cited above notes, as "a mass of shiftless moochers who don't contribute much, if anything, to society." David Corn, Secret Video: Romney Tells Millionaire Donors What He REALLY Thinks of Obama Voters, Mother Jones (Sept. 17, 2012). It is of a par with comments by a woman that I met at a reception in Boston over the weekend, who spewed scorn as she claimed that anybody that is on welfare or getting unemployment is just a lazy bum that wants the rest of us to hand them a living on a silver platter.  Romney's and the woman's comments both show absolute insularity from the real world of povery and near-poverty in America in the aftermath of Bush's Great Recession, when able-bodied men despair of their situation in being unable to find a job, any job, and young folks grow hopeless as they fill in application after application.  Without government programs to fill in the gaps for these groups, their lives would be truly desperate.  Their non-taxpayer situation has nothing to do with lack of personal responsibility and everything to do with a society in which the economy for too long has favored the uberrich at the cost of ordinary Americans.

Remember that the federal income tax is specifically designed to protect taxpayers in the lower income distributions from paying federal income tax through the use of the standard deduction and personal exemptions.   That's because Congress has always assumed that there should be a minimum below which the federal income tax does not reach.  And Congress has enacted a number of other exclusions and credits designed to ensure that the federal income tax doesn't fall too heavily on the more vulnerable amongst us.  

About half of those [46% of households] did't pay [federal income taxes] because of standard deductions and personal exemptions designed to exclude subsistence levels of income from taxation.  The rest received tax breaks, including the earned income tax credit, the child tax credit and tax benefits for older Americans such as the exclusion of Social Security benefits from income."  Richard Rubin, Romney's 47% With Not Taxes Combines Elderly with Poor Workers, Bloomberg Businessweek (Sept. 18, 2012). 

Furthermore, most taxpayers who pay no federal income tax do pay other taxes:  state and local income, property and sales taxes eat up a substantial amount of income, as do federal payroll taxes, which often amount to the most significant tax bite for these lower-income taxpayers.  And as the Rubin article also notes, people who don't pay income tax one year--because of returning for education, job losses, extraordinary medical expenses and other causes--come back on the tax rolls in later years when they finish studies or find work.

Regrettably, Romney's remarks at the fundraiser mainly reveal an eager player in the class warfare game that the right has engaged in for the last few decades--it reflects a firm support for tax policies that redistribute upwards to the elite, at whatever cost to ordinary Americans who are disdained and even despised as irresponsible and lazy.  With CEOs making 200-400 times what their average workers make and the productivity gains contributed most especially by the workers being siphoned off for increasingly higher pay for the executives, ordinary Americans already are hurting.  Tax policies that continue the rip-off by continuing preferential rates for capital gains, providing even more preferential marginal rates for the uberrich, and eliminating worldwide taxation on multinationals will do even greater harm to ordinary Americans and the sustainability of our economy.

Romney's Carried Interest and Capital Gains Rates Generally

As most everybody knows by now, Mitt Romney, the GOP nominee for president, refuses to release anything other than the 2010 tax return we've seen (and sometime soon, it is promised, the 2011 return).  Without more tax returns--and more complete return-related information--Romney is basically telling voters they have no right to know how he invests and earns his vast wealth. 

It just ain't so. 

First, voters have a valid interest in knowning how Romney invests his great wealth.  Passive investments, "hobby" investments, treatment of his later years at Bain Capital, treatment of his "retirement" income from Bain--all of those are of valid interest.  Then there is the question whether Romney has consistently held a lot of his wealth offshore during many years? And did he report his offshore accounts and income as he was supposed to, back in the days before Birkenfeld opened the crack in Swiss banking secrecy, or did he end up participating in the IRS amnesty program in order to avoid criminal prosecution for his failure to file FBARs?  We surely have a valid interest in those questions and more about the way Romney's wealth is held.

Second, voters have a valid interest in knowing (and understanding) how Romney acquired his great wealth.  Yes, he was born into a well-to-do household and that gave him an incredible leg up on every American who is not born into the lap of wealth, even before he received his inheritance  from his father's estate(which he purportedly contributed to charity).  But he claims to have a wealth of business expertise that will allow him to be a good president, and that rests on his role at Bain Capital.  But there he is caught up in the rarified world of equity fund managers--people who, through an interpretation of the Code, not through a specific provision providing for it, claim that their "carried interest" compensation income can be treated as capital gains rather than as ordinary income.  As a result, they pay a very low rate of tax.  And their "job" is to buy  out firms, almost always by leveraging them up so they can use other people's money to make the acquisition, and not infrequently by running them into bankruptcy, resulting in Mitt Romney getting to fire people (he said he enjoys it).

Bruce Bartlett, a veteran GOP economic adviser, even agrees with the majority of tax experts who have come out against the "carried interest" loophole and argues that it "can and should be addressed by treating carried interest as ordinary income."  See Economix- Bruce Bartlett, Mitt Romney, Carried Interest and Capital Gains, New York Times (Sept. 11, 2012).

Bartlett is correct that we can and should address the ridiculous carried interest loophole--it is well past the time that Congress should have acted to quit favoring the richest folk amongst us with preferential treatment of the compensation they receive for their asset-management activities.

But Bartlett is wrong about whether the effort to fix capital gains problems should stop there.  He argues against eliminating the capital gains preference with three well-hashed and relatively weak arguments.  Let me give you his arguments, and my responses, here.

1. First, he says, even if you got rid of the preferential rate, you wouldn't have completely eliminated the preference for capital gains in the Code, since gains aren't recognized until they are "realized"--meaning that the taxpayer has the ability to choose to dispose of a capital asset at the timing that suits him.  Gains can be deferred.  Losses can be accelerated.  (And they still avoid the payroll taxes that apply to wage income). 

The point is true but nonetheless not an argument against eliminating the preferential rate.  Congress is not likely to require mark-to-market rules, but it could easily write rules that make  monetization-without-taxation schemes  unworkable.  (One monetization scheme that has been often employed by wealthy taxpayer is to use shares as collateral for a loan, enjoy the money during life, and let the beneficiaires inherit the shares at stepped up basis and then sell them to pay off the loan--no cost in life; no cost to the beneficiary either.)  Another thing Congress could do to help prevent the "cherry-picking" of loss recognition-without-gain-recognition is to repeal the identification provision that allows taxpayers to pick out which of a bunch of identical shares (except for basis) they are selling.  Require all sales to be taken from all groups of shares.

The fact that eliminating the preferential rate for capital gains doesn't eliminate all the tax advantages that the wealthy will be able to enjoy from holding the vast majority of the financial assets doesn't mean that we should at least eliminate that significant advantage!

2. Second, he brings up the old saw about inflation and the fact that in times of significant inflation, the gain calculated as the different between current value and original cost basis will represent in part a "phantom" inflationary gain.  Indexing for inflation would be an administrative nightmare (that would invite wealthy taxpayer manipulation of the data, just as already happens with inflated bases).

The answer here is really "so what."  If we concede that taxpayers will still benefit--especially compared to ordinary income earners on whom taxes are withheld as the income is earned throughout the year--from having capital gains assets for which they can control the timing of taxation through the realization requirement, we should be quite willing to have a "rough justice" tradeoff the other way with whatever inflationary gains (or losses) may be represented.  This is especially true when one considers that the financial assets held mostly by the wealthy also give enormous other economic benefits during the time they are held--prestige, influence, and power are not to be ignored.   Further, the tax-free consumption power attained through monetization with loans (in circumstances in which it wouldn't be treated as a constructive sale, and depending on whether Congress would act to make monetization with no taxation impossible through elimination of the step up in basis on monetized assets) is another significant advantage.

3. The third reason given by Bartlett for not eliminating the capital gains preference is that it will be hard--people who get most of the capital gains preference are people of great wealth who "exercise influence in our political system far out of proportion to their numbers." 

This is a practical reality, but it is not a reason for deciding to retain the preference.  It is, rather, a reason for Republican and Democratic economists to speak up courageously and call for the repeal of the preference from the Code.  It is a reason for all of us to take the actions and policies of politicians favoring wealthy owners of capital into account in our votes.  It is a reason to think twice about electing a ticket (Romney-Ryan) in which both parties grew up in the upper middle class, have always had plenty of money, and don't have much understanding of what it is like to be down and out in America today.  It is a reason to find progressives who understand the problem of a tax code that preferences the wealthy plutocrats and corporate owners.

Romney and Private Equity's Questionable Schemes for Paying Very Little Tax

Presumably any American who wants to be informed is aware that GOP presidential candidate Mitt Romney's claim to business acumen resides in his experience at a private equity firm that made much of its money by ramping up debt at purchased firms and using that debt to repay whatever (usually relatively small) investment the equity firm partners made in what has come to be known as "LBO" deals (for "leveraged buyout").  In LBOs, the equity firm investors almost always do well to exceedingly well, using mostly other people's money. 

Not so generally for the workers in the bought-out company.  The "rent" profits of the equity firm are often on the back of the workers, who may get fired in favor of outsourcing their jobs or get stuck in a rut, as productivity gains go to the new managers and owners and not to the workers.  At the least, the high debt load makes it very difficult for the company to succeed and certainly difficult for it to give its workers a fair shake.   Remember that one of Romney's gaffs was to admit that he enjoys firing workers.

Why anybody thinks this kind of winner-take-all, leverage-'em-up mentality of private equity firms suggests the kind of leader desirable for a democracy that purports to provide genuine opportunity for all classes of citizens to live a decent life is beyond me. 

But even if the very nature of the business and the common tools of over-leverage and "rent" profits for a very few already at the top don't give voters cause for pause, then there are the many ways that private equity firm partners manage to avoid paying their fair share of taxes, which ensures that more of the tax burden falls on the less-well-off, that are worthy of consideration, even if candidate Romney has not (as his campaign claims) benefited from them personally.  That is because if Romney is elected president, his views on the acceptability of aggressive tax strategies of questionable legality will matter.  We should know what kinds of tax schemes are routine in the business that he touts as good evidence of his ability to serve as president of this nation--especially if some of them are obviously poor policy (the carried interest treatment) or highly questionable tax avoidance schemes (the management fee conversion waiver scheme).

I. Carried Interest

The best known way private equity firm partners reduce taxes is by earning their compensation in the form of "carried interest" and claiming that such profits should be treated the same way a real capital investment in a partnership is treated, even though it is awarded as compensation for their purported management expertise and work and not as a return on an actual investment made.   That is, they claim they are profits partners in the firm and that their compensation is a distribution of the partnership's profits (usually from gains on sales, and hence eligible for preferential capital gains) to them rather than compensation income.  As such they benefit from the extraordinarily preferential rate for capital gains in the current law as enacted under the Bush administration (generally 15%).  Carried interest is the primary reason that candidate Romney has to pay such a very low rate of taxes on his income from his business.

The Internal Revenue Code (the codification of the federal statutes governing the federal income tax) does not include a specific provision governing profits interests and indicating that such "profits" partners should be treated as actual partners in a partnership (without that partnership interest itself being subject to tax as compensation) entitled to receive capital gains distributions.  Accordingly, as one partnership tax treatise puts it, the tax treatment of a transfer to a "service partner" of a "profits interest" for services "has been uncertain" because "[n]o provision of the Code specifically exempts from taxation the receipt of any partnership interest in exchange for services."  Willis & Postlewaite, Partnership Taxation, 6th ed, at 4-124.    There is some caselaw about profits interests, but those cases made it even less clear how and when such interests should be taxed. 

Finally, the Service resolved the issue with administrative authority (heavily lobbied for in the interests of equity partners and real estate profit partners, in particular) in Rev. Proc. 93-27 (and later proposed regs and other items) that does not treat the issuance of a compensatory "profits interest" as  a taxable event in most instances.  The main reason for the treatment may well be the so-called "Wall Street Rule"--once incredibly wealthy taxpayers hire sophisticated, high-priced lawyers to produce opinons supportive of a taxpayer-favorable interpretation and then operate as though the Code blesses a particular activity, it is hard for tax administrators to issue regulatory authority that treats that activity differently.

2, Management Fee Conversion Waivers

But there is another lesser-known aspect to the compensation that private equity fund partners earn for their services in their private equity firms--the management fee.  Most explanations describe this as  compensation paid for services that is subject to taxation at the ordinary rate (just like a secretary's wages would be).  But that disregards a practice that exists among a significant number of equity firms (the Times article linked below says about 40% in 2009) that are willing to take aggressive positions to avoid paying taxes and can afford to pay the tax professionals to provide a way to do it--the management fee waiver conversion scheme. 

The conversion of management fees from ordinary income to capital gains is purportedly accomplished by "waiving" the fees (not necessarily across-the-board throughout the life of the firm, but often selectively and on a quarter-by-quarter basis),  Instead of getting fees, the partner claims they are "converted" to a share of related profits --i.e., they become an additional carried interest--and hence eligible for treatment as (deferred) capital gains from the firm.  

Some tax professionals think this conversion waiver works.  Much of this is again the "Wall Street Rule"--the claim that lots do it, the IRS has known about it, and oh it should be justifiable because now the "fee" is (sort of, maybe, kinda) at risk.  It is not really at risk in the way we ordinarily think of investment risk, since these are pre-tax dollars -- the managers are not putting after-tax dollars at risk like any other investor is doing.  And as Vic Fleischer commented to the gothamist blog, "there is a tension between economic risk and tax risk .... The way Bain set it up there's not much risk at all, so it's hard to see how this income should receive capital gains treatment."  Christopher Robbins, NY AG: Bain Capital and others may have skirted tax law, the Gothamist (Sept. 2, 2012).  

I'd guess  that most professionals do not think the conversion scheme works, at least not in most instances.  This would be especially true for those who consider that interpretations of the law should further coherent bodies of law that work as fairly as possible.  And even more tax professionals likely think that the partnership rules should be adjusted to ensure that it doesn't work, since otherwise we are perpetuating inequities in the tax system that favor the already incredibly rich.

The conversion waiver issue has come to the attention of the public now because the New York State attorney general is investigating private equity firms who may have engaged in this conversion waiver practice.  See Nichnolas Confessore et al, Inquiry on Tax Strategy Adds to Scrutiny of Finance Firms, New York Times (Sept. 1, 2012) (noting that the AG's subpoenas, issued by the AG's Taxpayer Protection Bureau, cover firms like Kohlberg Kravis, TPG Capital, Apollo Global, Silver Lake and Bain, and that Bain partners may have saved more than $200 million in federal income taxes, $20 million in Medicare taxes). 

It's not clear on what grounds the New York AG is investigating this issue, which appears on the surface to be primarily a federal income tax issue.  It could be some sort of state-law fraud claim but it could also be a claim that underpayment of state taxes routinely results from the filing posture taken,  Equity partners in firms using the conversion waiver would presumably be able to save on state income taxes through either rate preferences and/or deferral, depending on the state and how much the state's laws build on the federal filing.  Though New York State does not have a preferential rate for capital gains, if the timing of reporting the income is set by the conversion waiver, the deferral would amount to a significant state tax savings that deprives New York of needed revenues. 

[Aside:  By the way, some of the information about the management fee conversion waiver first came to broad public attention in connection with Bain and the trove of documents released at Gawker.com.  See John Cook, The Bain Files: Inside Mitt Romney's Tax-Dodging Cayman Schemes, Gawker.com (Aug. 23, 2012) (noting that the huge cache of Bain financial documents "shed a great deal of light on those finances, and on the tax-dodging tricks available to the hyper-rich that [Romney] has used to keep his effectie tax rate at roughly 13% over the last decade").   These documents, and the further analysis articles available at the Gawker.com site, are worth considering for their own revelation of what Romney's real business is like and how that does (or doesn't) suggest he can help our economy as president--it is a business where "opaque complexity" allows the "preposterously wealthy" to engage in "exotic tax-avoidance schemes", according to the Gawker.com article.  (I have not yet personally perused much of the 950 page trove on Gawker.)  That said, Romney's campaign issued a statement indicating that the candidate has not benefited from the conversion waiver practice.  We have not, of course, seen enough of Romney's tax returns and supporting information to be able to judge this matter independently.  The focus on the conversion waiver thus provides yet another reason why candidate Romney should release 10 years of tax returns as other candidates have done.]

There are two additional readable pieces on this conversion waiver issue, plus a scholarly article that anyone wanting to better understand the details can peruse.  Vic Fleischer, a tax prof at Colorado who made his original contribution to academe by writing about carried interest, has an article that sets out the issues well, with an example contrasting the significant difference in after-tax results for a real investor compared to a profits-interest purported investor.  See Victor Fleischer, What's at issue in the private equity tax inquiry, DealBook, New York Times (Sept. 4, 2012). See also Brian Beutler, Did Bain Capital Execs Break the Law Using a Common Tax Avoidance Strategy? Talkingpointsmemo.com (Sept. 3, 2012). The academic piece is Gregg Polsky, Private Equity Management Fee Conversions (Nov. 4, 2008).  The following two paragraphs are from the conclusion to that piece.

In fact, there are strong arguments that it is not. While managers argue that the safe harbor in Rev. Proc. 93-27 applies to the additional carried interest, there are both technical and conceptual claims to the contrary. Without the protection afforded by Rev. Proc. 93-27, the additional carried interest would be taxable upon receipt if it has a market value capable of determination. Both the context in which the additional carried interest is issued and the specific design features of the typical additional carried interest support the view that additional carried interests are significantly easier to value than prototypical profits interests.Under existing caselaw, this would mean that the additional carried interest is taxable upon receipt as ordinary income to the extent of its fair market value.

The IRS also has strong arguments under section 707(a)(2)(A), which recasts transactions that are artificially designed as partnership transactions in order to obtain tax benefits, such as character conversion. In the context of fee conversions, the most critical fact that favors section 707(a)(2)(A) recharacterization is the manager’s very limited exposure to risk. As a result, section 707(a)(2)(A) likely applies to fee conversions. If so, the manager’s attempt to convert the character of their management fee income would be thwarted.

 

Romney's Private Equity Magic Trick--equity manager's gain, taxpayers' losses (Reich Video)

Mitt Romney claims that his business experience at Bain Capital is a superb qualification for the presidency.  He implies that this experience will carry over to his economic policies, with the suggestion that he will become a "job creator-in-chief" like all those one-percenters purportedly are in the private sector.

In reality, private equity experience is a recipe for disaster in the White House.  Think about what private equity firms do.  They take an ongoing business--usually one that is making decent profits and paying its workers decently--and they make it into one that can pay outsized "rent" profits to the private equity firm.  Usually, though not always, this means cutting costs and adding debt. 

The debt is an elixir for private equity firms.  Because interest is deductible, it actually increases profits by lowering the company's federal income taxes; yet because it isn't required to be used by the firm to actually improve the products or services offered, it is often used instead to pay dividends to the private equity firms, paying off whatever actual investment the private equity firm made in the company. 

Cutting costs is the way for private equity firms to extract even more gravy from their target company.  Cost cutting is most often directed at

• firing workers and making fewer workers do the same work that more workers used to do (that's called a "productivity" gain, garnered, of course, by the private equity firm and not by the everyday workers), and/or
• outsourcing jobs to other countries so that labor can be paid less than a going wage in this country (that's often coupled with step one, since workers are no longer needed in this country--sometimes the US workers are even required to train their cheaper foreign counterparts before they are let go, and of course those "effiencicy" gains are garnered by the private equity firm and not by the remaining workers), and/or
• cutting wages and benefits for the remaining workers (and shipping those extra "savings" out as dividends to the equity firm investors), and/or
• innovating better administrative systems (this can be a good deal--for example, putting money  that the company didn't have until the new "investors" came in into digital record systems or improved communications systems, but it can also be a bad deal, if the firm uses its new technology to game the federal system on taxes, or Medicare reimbursements, or federal contracting or similar items)
  • Consider the fact that Bain and other private equity firms purchased a for-profit hospital.  One of the "improvements was to redesign the coding system for patient services to increase the reimbursements from Medicare and thus hike up the hospital system's profits, which are garnered by the private equity firm.  Julie Creswell and Reed Adelson, A Giant Hospital Chain is Blazing a Profit Trail, New York Times (Aug. 15, 2012), at A1 (noting that Medicare reimbursements for the highest classifications surged to $949,000 in 2010 from $48,000 in 2006 at one hospital, in a story about Bain Capital and other equity firms'  profit improvements at HCA, where nurses and doctors express concerns about profit-making that is driving decisions that shortchange patients through understaffing and/or shortchange the government, as in the new coding system that caused the Medicare reimbursements to skyrocket); see also Steve Denning, HCA: The unsustainable private equity bubble in US health care, Forbes (Aug. 15, 2012).
  • As one commenter on the NY Times article noted, "To be more profitable as a healthcare facility requires ... having more sick people to treat, or hav[ing] higher charges.  Both are inhumane."  Munz, New York, NY.  And as one former HCA employee commented, "patient safety and medication safety came in a distant 2nd to conformity and [the] draconian measures to make care more efficient."

These kinds of activities go hand in hand with the increasing consolidation into mega-business enterprises (regrettably aided by the tax code's "tax-free reorganization" provisions, that were also made much more flexible during the Bush years in order to facilitate such consolidations).  Big businesses reap the productivity gains of their workers for the few managers and significant shareholders at the top, and either buy  or compete with local and family-owned small enterprises to put those smaller and shallower-pocketed (and less well-connected) business out of the way, thus separating more and more businesses from the communities in which they are located.  All in all, not good for America, and not the kind of skills one wants in the presidency, where we need someone who can see the relationship between the stability of small businesses, viable communities, and stable workers.

For a clear and understandable demonstration of the way private equity firms make their money and who wins (and who loses) from those methods, see Robert Reich's video chat on the subject:

ect:   

More on Greg Mankiw's weak arguments for the Bain capital gains preference

A few days ago, I commented on the weak arguments Greg Mankiw had put forth in his op-ed to support the preferential treatment of compensation for private equity and real estate partnership "profits" partners.   He points out the categorization problem--that it is not always easy to be sure what is a "capital gain" and what is "ordinary income".   I concluded along the lines of arguments I have repeatedly made on this blog:  the main thing the categorization problem teaches us is that we should eliminate categorization problems that create inevitable inequitable differentiations by eliminating the category difference. 

Get rid of the preferential rate for capital gains (and with it the need to distinguish capital gains from ordinary income), and you will in one stroke simplify corporate and partnership and individual taxation tremendously.  Much of the Code is invested in trying to prevent smart tax lawyers from using tax alchemy to convert one type of income into another.  See, e.g., section 1059 (extraordinary dividends to corporate shareholders), section 304 (sales between affliated corporations treated as redemptions), section 302 (providing tests that, if not satisfied, treat redemptions as dividends if there is e&p), etc.

Uwe Reinhardt makes a similar argument in the Economix blog carried by the New York Times.  See Capital Gains vs. Ordinary Income, New York Times Economix Blog (Mar. 16, 2012).   Reinhardt uses Mankiw's own introductory textbook in microeconomics to make the tax equity argument that many have been making about carried interest--it is unfair to tax a money manager at a preferential rate compared to firemen, postal inspectors, college professors, school teachers and neurosurgeons.

In his popular textbook “Principles of Microeconomics,” Professor Mankiw teaches students that “horizontal equity states that taxpayers with similar ability to pay should contribute the same amount.” Well put.

Consider now a person who bought a vacation home for $500,000 and two years later, during one of our recurrent real-estate bubbles, sells it for $1.5 million. That $1 million profit is now taxed at a rate of only 15 percent. If the home had been the principal residence of this person and his or her spouse, half of the $1 million profit would not be taxed at all.

Suppose next that this tax-favored person’s neighbor were a busy neurosurgeon whose many hours of hard, physical and intellectual work earned him or her a net practice income of $1 million during those same two years. That neurosurgeon would pay the ordinary income-tax rate on that income (on average a bit less than 35 percent, because only income over $388,350 a year is taxed at 35 percent).

By what definition of the term would can one call the glaringly differential tax treatment of the real estate investor and of the neurosurgeon horizontally equitable?

Reinhardt goes on to make another of the arguments that I have been pressing for months in this blog--that the assertion that preferential rates are necessary for stock market transactions because they are rewarding investment in the corporations is baloney--most reported gains on securities are from secondary market trades, not from direct investments in corporations. 

[T]he proponents of lower capital-gains taxation conjure up an image of, say, Jones purchasing shares of stock directly from the issuing corporation, which then invests the proceeds in new structures and equipment.

More typically, however, sales and purchases of corporate common stock take place among parties quite outside of the issuing corporation. For example, Jones may buy the stock from Chen, who may have reaped a capital gain from once buying and now selling the stock. Chen may have bought the stock from another person not related to the issuing company.

When Jones pays Chen, it is anybody’s guess what Chen does with the money. For all we know, Chen will spend it on a luxury car. Why, then, should any gain Chen enjoys on his or her investment in that stock be granted a tax preference? No new capital formation was supported by this trade in a stock sold by the company years ago.

The ugly truth about the  insistence on the capital gains preference is that it rewards people at the top of the income and wealth distribution and serves to maintain the status quo of the allocation of resources.  This is what is really meant by "fiscal conservatism" these days--ensuring that resources remain inequitably distributed to the very wealthy who are the "shakers and movers" of society through the influence their money can buy.  The right-leaning Supreme Court has made that even more inevitable than it was before, through the Citizens United decision upholding the right of corporations to contribute any amount to influence political campaigns, based on the laughable assertion that such "super-PAC" rights undergird free speech.