Canadian Romney would pay less tax; Investment income preferred
Under increasing pressure, Republican presidential candidate Mitt Romney this week released both his 2010 tax return and his 2011 estimated return.
While his income numbers were staggering, placing Romney among the wealthiest U.S. income-earners, it was the relatively low taxes he paid and is expected to pay for 2011 that has been the subject of intense water cooler discussions.
In 2010, the presidential hopeful had reported gross income of US$21,661,344, made $2,983,974 in charitable donations and paid $3,009,766 in federal taxes, resulting in the effective 13.9% tax rate that has raised the ire of many hard-working Americans who make substantially less but pay tax at a higher effective rate.
His income for 2011 is estimated to be slightly less, at US$20,901,075. Last year he made charitable gifts of $4,020,572 and is estimated to pay federal tax of $3,226,623, making his 2011 effective tax rate 15.4%.
The issue of Romney's wealth has dogged him throughout his campaign to be selected as the Republican presidential nomination, as Americans wondered whether his enormous wealth, estimated at more than US$250-million, could impede his ability to be president and relate to the average American. Much of his wealth can be attributed to being a founding partner of Bain Capital, a venture capital and private-equity firm he started in 1984.
But this week was the first real glimpse into his finances. He has never released his personal tax info before, even when he was the governor of Massachusetts.
On Tuesday, Romney's campaign office released over 500 pages of tax documents. His 2010 tax return, prepared by the accounting firm PricewaterhouseCoopers, was 203 pages. Buried in all those pages are disclosure about a Swiss account that was closed in 2010 and accounts in Bermuda and the Cayman Islands.
For many Americans, his tax rate seemed low, considering the U.S. top personal tax rate in 2010 and 2011 was 35%. But Romney earned more than half of his income from capital gains and dividends, which are taxed at only 15%.
Contrast Romney's return with current President Barack Obama, who disclosed a gross income of $1,728,096 for 2010 when he released his returns in April 2011. Much of Obama's income comes from sales of his books Dreams from My Father and The Audacity of Hope. In 2010, he paid $453,770 in federal taxes, making his effective tax rate 26.3%.
But if Romney were filing Canadian taxes, we estimate he would have paid even less, even though Canada's tax rates are generally considered substantially higher than the U.S.
Running the U.S. numbers on a Canadian return, assuming no foreign currency adjustment and assuming his dividends would be Canadian dividends had he lived in Canada, Romney would have paid $2,973,021 of Canadian federal tax in 2011 on his $20.9-million of income, which translates to an effective federal tax rate of only 14.2%, more than a percentage off the 15.4% he is forecast to pay.
If we consider state or provincial taxes, Romney's effective U.S. rate increases to 21.8% and his Canadian rate to 22.7% if he were living in Ontario. If he were an Alberta resident, his effective rate would be a mere 16.1% since Alberta provides a very generous credit for charitable donations.
Romney and other rich Americans and Canadians are able to pay a lower tax rate because of how investment income is taxed as well as the value of the charitable donation tax credit.
In Canada, dividend income is eligible for a dividend tax credit while capital gains are only half taxable. In other words, for a top income earner, Canadian dividends are taxed a top federal rate of only 17.72% (2011) while capital gains for a high income earner would be taxed at half the top marginal tax rate or 14.5% (i.e. 50% x 29%). Charitable donations above $200 are eligible for a 29% federal donation credit.
When we consider that Romney's 2011 income was made up of US$3.1-million in dividends and $10.7-million worth of capital gains, combined with $4-million of charitable gifts, it's possible to see how Romney or, for that matter, anyone who earns the bulk of their income from investments, ends up paying very little tax.
The Romney story also serves as an important reminder of the difference between your marginal tax rate, which is the amount of tax you pay on each additional ("marginal") dollar of income above a certain level, and your effective tax rate, calculated by dividing your tax liability by your income.
For most Canadians, your average tax rate is significantly lower than your marginal tax rate, especially if the bulk of your income comes from tax-preferred investments.
But the last word goes to Romney himself. As he said in Monday's debate on the eve of releasing his tax returns, "I pay all the taxes that are legally required and not a dollar more....Will there be discussion? Sure. Will it be an article? Yeah. But is it entirely legal and fair? Absolutely."