Mr. Punky Kitten: Obama’s misleading tweet on Romney’s taxes

Question: When the Washington Post assigns Obama's latest tweet 3 Pinocchio's (out of 4), does that mean they are calling him a liar?

3 Ponocchio's, according to their site, represents: "Significant factual error and/or obvious contradictions."

http://www.washingtonpost.com/blogs/fact-checker/post/obamas-misleading-tweet-on-romneys-taxes/2012/07/06/gJQAN3DTSW_blog.html

"FACT: In 2010 and 2011, Romney paid less than 15% in taxes on $42.5 million in income—much less than what many middle-class families pay."

— Tweet by @BarackObama, July 3, 2012

We are avid readers of tweets by @BarackObama, though of course it is not the president himself but his campaign team that posts them. We are also very curious when politicians claim they have uttered "a fact."

So, is it really true that the presumptive Republican presidential nominee, who is very wealthy, pays a tax rate "much less" than "many" middle-class families?

The Facts

Romney released his 2010 tax return and an estimate of his 2011 return earlier this year. He earned a little more than $20 million each year, a good chunk of it in capital gains and dividends, which are taxed at a preferential rate as low as 15 percent.

But that's not the only reason why Romney's tax rate is at that level. He also donates about 14 percent of his income to charity, which gives him a pretty big tax deduction. (As we have noted, President Obama in 2010 also gave about 14 percent of his income to charity.)

Indeed, Romney gives about as much to charity — $3 million — as he pays in taxes. Those itemized deductions are counted against income that would ordinarily be taxed at a 35-percent rate. We figure that without those donations to charity, his effective tax rate would be at least 19 percent.

(For more information, see the nifty interactive graphic by the nonpartisan Tax Policy Center showing how Romney's and Obama's tax returns match up against a typical middle-class family. You can see that Obama's itemized deductions also lowered his effective tax rate, compared to the rate for Vice President Biden, who had fewer deductions.)

Nevertheless, the Obama campaign is correct that the former Massachusetts governor paid about 15 percent of his gross adjusted income (that's line 37 on the tax return) in taxes. But is that "much less" than what many middle-class families pay?

First of all, most of Romney's taxes are federal income taxes. He pays relatively little in payroll taxes because the 6.2 percent Social Security tax maxes out once you earn a certain amount — $110,100 in 2012. Romney in effect earns that much by Jan. 3.

But for most Americans, payroll taxes are the biggest tax item. (And that's not even including the share paid by employers. Most economists say employers pay for payroll taxes by cutting their employees' wages.)

People often confuse marginal tax rates with effective tax rates. Marginal rates are what you pay on each additional dollar of income, so that can be as high as 35 percent. The effective tax rate is the percentage of taxes you pay after deductions, adjustments and the like.

The Congressional Budget Office and Internal Revenue Service have produced estimates for effective tax rates, but the data are relatively old — 2008 and 2009, respectively. Both also have limitations. The IRS data rely on information from actual returns, but thus miss people who don't file tax returns; the CBO tries to compensate by using estimates of income from untaxed sources and for people who don't file tax returns. There are also issues concerning what types of income to include in the definition.

To keep things simple, we are going to rely on a chart of effective federal tax rates produced by the Tax Policy Center. The chart shows the effective tax rate as a percentage of AGI, divided into quintiles, with the values based on a concept known as cash income. (Here's a definition.) Cash income is not quite the same as adjusted gross income, but Roberton Williams of the Tax Policy Center said the AGI numbers in the charts would provide the closest apples-to-apples comparison to Romney's tax return.

Using the Tax Policy Center analysis, we will present the data two ways — without and with the employer-paid share of payroll taxes. The income figures are rounded. The first method is the closest equivalent to Romney's tax return.

Effective Tax Rates (taxes paid on tax return)

Bottom 20 percent (0-$17,000): -5.8 percent

Second 20 Percent ($17,000-$33,500): 1.3 percent

Middle 20 percent ($33,500-59,500): 9.2 percent

Fourth 20 Percent ($59,000-$103,500): 12.9 percent

Top 20 Percent ($103,500+): 20.6 percent

Effective Tax Rates (also including payroll tax paid by employer)

Bottom 20 percent (0-$17,000): 1 percent

Second 20 Percent ($17,000-$33,500): 7.8 percent

Middle 20 percent ($33,500-59,500): 15.5 percent

Fourth 20 Percent ($59,000-$103,500): 18.7 percent

Top 20 Percent ($103,500+): 24.3 percent

First, one can see that for all the rhetoric about high taxes in the United States, most Americans pay a relatively small percentage of their income in taxes. Second, Romney had an effective rate of 13.9 percent in 2010 and 15.4 percent in 2011, which gives him a higher rate than 80 percent of taxpayers in the first method and puts him just about in the middle of all taxpayers in the second method.

No matter how you slice it, his tax rate is not significantly lower than the tax rate paid by middle-class Americans.

The Obama campaign countered our analysis by pointing out that the tweet used the phrase "many," not "most," and by providing a dictionary definition showing that "many" means "a large amount." The campaign also noted that a White House report showed that while the median tax rate for Americans with income between $50,000 and $100,000 is 13 percent, some 3 million face effective tax rates above 21 percent.

Under the campaign's logic, this translates into Romney paying a rate "much less" than "many" Americans, though with the same data, one could say that many more pay a lower rate than Romney.

It is not our job to determine whether that is a good or bad thing. The U.S. tax system is designed to be progressive, meaning the rich are generally expected to pay higher taxes than the less wealthy. Politically it may not be smart for Romney, with an annual income topping $20 million, to end up with a tax rate so similar to middle-class tax rates. But we are also reminded of Judge Learned Hard's observation in 1935:

"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."

The Pinocchio Test

The Obama campaign's tweet relies on a very slippery "fact."

Romney, by receiving much of his income in capital gains and dividends and giving millions of dollars to charity, is certainly able to keep his effective tax rate relatively low, especially compared to a wealthy person who earns much of his or her income in salary. But, even so, Romney still pays an effective tax rate that is higher than the tax rate paid by most Americans.