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Baucus, Dems see opportunity to tax the rich

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The average Missoulian makes about $35,000 a year, which means most of us pay less than 15 percent of our income in federal taxes.

Republican presidential candidate and former Massachusetts governor Mitt Romney paid an effective tax rate of 13.9 percent on his $21.6 million in income in 2010, as he disclosed last week.

Montana Sen. Max Baucus isn't thrilled about that.

The release of Romney's tax returns fanned the flames of the debate over income inequality that was ignited last year by the Occupy movement. It's also heightened scrutiny of private-equity firms, which buy companies, increase their value and sell them or take them public. Romney co-founded the private-equity firm Bain Capital. He made $12.9 million from Bain in 2010.

Romney's opponents in the Republican primary have described his work in private equity as "vulture" capitalism. James Surowiecki of The New Yorker wrote this week, "Not since the days of Wall Street and Barbarians at the Gate have the masters of leveraged buyouts looked quite so bad."

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  • Congressional Budget Office
  • Cumulative Growth in Average After-Tax Income, by Income Group (Percentage change in income since 1979, adjusted for inflation)

The way private-equity fund managers make so much money has looked bad to Baucus for quite a while. Since 2007, he's worked to change the tax code's treatment of "carried interest," the share of profits that partners in private-equity firms receive as compensation. Such income is taxed at the long-term capital gains rate of 15 percent, less than half of the average federal tax rate for the top one percent of earners. Which is why Romney, whose fortune is estimated at around $250 million, pays in taxes a comparable percentage of his income as a writer at the Indy.

"The carried-interest loophole is an outrage, and that's why I've fought tirelessly to close it," Baucus says. "There is no reason someone like Warren Buffett should pay less interest than his employees, and that's why I'll keep working as hard as I can to fix this."

Baucus, a right-leaning Democrat and chair of the Senate Finance Committee, held three hearings on carried interest in 2007. He sought to determine whether carried-interest income is a legitimate capital gain or a case of "people of great wealth merely taking advantage of the tax code to pay less than their full and proper share."

Those hearings failed to result in changes to the tax code. Since 2007, carried-interest reform has passed the House four times, only to die in the Senate. In 2010, Baucus introduced legislation to tax carried interest as ordinary income, but Republicans blocked it.

President Obama has suggested the same in his budget proposals.

Now Baucus hopes the conversation about income inequality begun by the Occupy movement, exemplified by Romney and channeled by Obama during last week's State of the Union address will result in finally closing the carried-interest loophole and raising taxes on the wealthy. There's already evidence of that: The "Buffett Rule," a 30 percent minimum tax rate for millionaires, which Obama advocated for in his speech, was introduced in the Senate on Wednesday. And increasing the tax rate on capital gains appears inevitable.

In 2008, capital gains accounted for 57 percent of income earned by the country's richest 400 taxpayers, who paid an average tax rate of about 17 percent.

"Democrats, in focusing on the tax cuts of the last decade and suggesting that those tax cuts primarily benefited more wealthy individuals...combined with what's happening with the economy, have certainly caused...a real spike in terms of public attention when it comes to what would be an appropriate rate of tax," says University of Montana law professor and tax expert Martin Burke.

The tax on long-term capital gains has fluctuated for decades. Under President Carter, the top tax rate on capital gains dropped from 39 percent to 28 percent. In 1981, the rate dropped farther, to 20 percent. President Reagan's Tax Reform Act of 1986 sent the rate back up to 28 percent. Under President Clinton, it dropped back to 20 percent. In 2003, under President Bush, it fell to 15 percent, while the rate on dividends—profits paid by a company to its shareholders—fell from a top rate of 35 percent to 15 percent. Those cuts were set to expire in 2010. President Obama and Congress extended them through this year.

Why the preferential treatment for long-term capital gains? Burke says that because the value accrues over time, some believe it's unfair to tax it in one year. There's also concern about the mobility of capital: The tax can be a disincentive to sell an asset and invest in something else. Baucus will be weighing these arguments as he seeks bipartisan reform.

"I think [Baucus] genuinely believes that we ought to have Democrats and Republicans come together and agree on something that works generally for everybody," Burke says. "And so I applaud his efforts in that regard. Whether he will succeed as chair of Senate Finance in terms of crafting some kind of compromise in the next year regarding taxes...remains to be seen."

Baucus and fellow Democrats have some leverage now, however. The Bush tax cuts are set to expire at the end of the year. If nothing happens, the tax on long-term capital gains will revert to the top rate of 20 percent under Clinton. Add a 1.2 percent hike due to the return of an obscure provision that reduces the value of high-income taxpayers' itemized deductions and a 3.8 percent hike included in the Affordable Care Act, and the rate is scheduled to jump in 2013 to 25 percent.

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