When Mitt Romney conceded on Jan. 17 that he pays a tax rate of about 15 percent—far less than millions of wage earners whose votes he’s trying to win—he deflected criticism by employing what might be called the Ordinary Rich Guy Defense: Like a lot of people who are wealthy enough not to work, Romney said his income “comes overwhelmingly from investments made in the past.” That’s not quite the whole story. What he left out is that, because of the way he made his money, he is eligible to take advantage of a special tax provision that even some of his richest friends would envy.
Private equity executives such as Romney, who spent 15 years running Bain Capital, arrange to receive much of their compensation in the form of “carried interest.” This enables them to treat what would be work income for most people, taxed at rates up to 35 percent, as capital gains, taxed at just 15 percent. “It’s a method of converting one’s labor into capital gains in a way that’s unusual outside the investment management industry,” says Victor Fleischer, an associate law professor at the University of Colorado at Boulder whose 2007 paper on the topic helped spur calls in Congress to change the law. “Ordinary people wouldn’t be able to do this.”