I would venture it’s possible that the media have spent as much time during the 2012 presidential campaign discussing the tax returns of one man, Mitt Romney, as they have covering the two candidates’ proposals for the other 300 million Americans’ taxes. Worse, most of this coverage has been highly misleading, playing on the suspicions Americans hold about offshore corporations and Swiss Bank accounts to imply that Romney is using these structures to evade taxes. It’s understandable when the Obama campaign and Think Progress do this; it’s significantly worse when ostensibly responsible outlets such as ABC News and the Washington Post leave out crucial information that explains why Romney is doing what he’s doing, suggest that such practices are notorious indicators of tax evasion (even when they’re not), and lead the reader to conclude that Romney must be engaging in the same practices. (The most embarrassing example of this was Vanity Fair’s “exposé” about Romney’s finances, though at least one expects that from its author, who knows that Romney’s dealings are common and legal, but has made a political career out of arguing that they’re deeply unjust.)
The latest attack on this front came above the fold on page A1 of the New York Times this morning, entitled “Offshore Set-Ups Helped Romneys Increase Wealth.” While you wouldn’t notice at first, the word “wealth” in that headline is actually something of an admission that most of the accusations leveled at Romney — that via offshore corporations he has evaded taxes in order to increase his income — aren’t true. Like any American, all of Romney’s income, no matter where it’s located or generated, is subject to the applicable taxes, whether it’s capital gains, interest, or dividends — taxes he will have to pay to the IRS’s satisfaction before he repatriates any of his offshore wealth.
The authors are even so generous as to admit that, “contrary to veiled assertions by some of Mr. Romney’s Democratic foes, hiding assets from the Internal Revenue Service is probably not part of their rationale.” (“Almost definitely not” would be better, but this is the Times.) Rather, the main contention is that Romney’s income and wealth have grown because the structure of Bain funds has attracted foreign and American tax-exempt investors — this, for once, is actually true.
The explanation for this is basically simple and banal: The main reason why many of Mitt Romney’s assets are located offshore, in notorious tax havens, is because alternative-investment vehicles (for the most part, hedge funds and private-equity funds) want to attract foreign investors. If those funds are set up in the United States, the foreign investors would be subject to U.S. taxes, and Bain Capital will have a very hard time attracting their capital. Much of the world’s institutional wealth available for alternative-investment funds is not in the United States, and and if they were subjected to extra tax when investing here, the U.S. financial-services industry would be far less competitive. The Times’s tendentious point is that when Bain’s funds attract more foreign investors, the cut Romney gets of Bain’s profits increases, and thus, yes, Romney’s wealth is indeed increased. The scary part, of course, is that in order to make investment in an American fund (which for the most part invests in American corporations) possible, Bain only lets the IRS get its hands on the returns due to U.S. investors, the income made by Bain managers, and the corporations the fund invests in, but not income generated from foreign investments by citizens of other countries. How horrible.
There’s a second reason the Times mentions as to why some of Mitt’s investments have complex overseas structures: His IRAs, in which most of his investments are located, are generally tax-exempt, but much of his wealth, in private-equity funds, generates what the IRS considers business income, on which the IRS tries to levy an unrelated-business-income tax (UBIT), since tax-exempt entities (more commonly, universities or charities) shouldn’t be generating business income. But it is also self-evidently obvious that such institutions as universities, hospitals, and charities, should not and do not pay taxes on their investment income.
However, private-equity funds, because the entities they use purchase and run corporations directly, often generate returns that look like business income, subject to UBIT — but they are really just investment returns, and therefore tax-exempt entities like Romney’s IRA or a university’s endowment shouldn’t owe taxes on them. Thus, as the Times explains, funds like the one Romney invests in “us[e] offshore blockers to avoid the tax” — that is, the IRS allows them to set up foreign corporations which exempt their investment income from taxes, as they should be allowed to. These blockers are entities in tax-free jurisdictions that absorb the business income, and then pay it out as dividends, which is not unrelated-business income, to the investment funds themselves. It’s also almost definitely a tiny amount that he’s actually avoiding — globally, this practice costs the U.S. treasury a whopping $100 million a year, so while the Bain funds as a whole might owe an amount worth avoiding, Romney doesn’t, and his income just happens to come via the same structure. The structure I’ve just described is something that would be quite available to ordinary Americans, too — if they were to invest in alternative investments with a huge potential for loss, which, for good reason, they don’t.
The article also discusses the ways in which Bain funds structure credit facilities abroad in order to reduce tax liabilities, and I won’t go into the details here (the Times itself admits that the issue is basically incomprehensible). Suffice it to say that all American corporations perform such activities, and any American who is an investor in them benefits from such “tax efficiency” strategies.
The Times, however, still suggests that this, and other issues, are examples of ways in which “elite investors like Mr. Romney are able to increase their fortunes in ways unavailable to most taxpayers.” This is only true inasmuch as “most taxpayers” don’t invest in private-equity funds trying to attract foreign investors, and their retirement accounts will never generate UBIT. The strategies the Times discusses allow Romney to prevent his investments from being taxed in ways over and above what “most taxpayers” would be burdened with, not privilege him in particular ways. The complicated strategies and significant resources devoted to ensuring that Bain investors don’t pay excessive amounts of taxes are only employed because of the foreign investors and types of income involved — since ordinary taxpayers don’t encounter these issues, of course they don’t need or use such strategies. The most significant effect of Romney’s tax arrangements, by far, is that his IRA investments are growing tax free — something almost all Americans take advantage of, too.
Further, these strategies are far from sneaky efforts only employed by the greediest of corporations — the constant refrain that Romney’s taxes are more “mysterious” or “opaque” than everyone else’s is merely his use of these kinds of investments, which are indeed rare for individuals (unless, of course, you count the millions of union workers who have their pensions invested with such things). There’s nothing exceptional here: Investment managers actually are professionally obligated to ensure that their investors don’t owe more taxes than they should. The Times also, finally, admits this, quoting a tax lawyer as saying, “Private-equity-fund managers have a responsibility to their investors to maximize their investors’ returns, and part of that responsibility involves minimizing taxes.” Unlike the personal discretion Romney can apply to his personal income taxes (as he did in 2011), Bain has no choice but to structure its investments in a way that will avoid unnecessary taxes for foreign investors, and defer payment of some others. Romney himself often doesn’t benefit from this at all, but when he does, it’s not out of his own volition, but just as a result of sound management.