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Friday, October 29, 2004

Mrs. Kerry's Missing Income

Mrs. Kerry’s Missing Income

Michael Kinsley, writing in last Sunday’s Washington Post, finds it unfair to complain that Teresa Heinz Kerry paid a paltry 12.4 percent federal tax on her reported $5.1 million in taxable income. “Whatever point Teresa Kerry’s critics were making,” he writes, “is wrong as well as utterly obscure.” At a superficial level, Kinsley is right. The Wall Street Journal editorial page made much too much of the fact that half of Mrs. Kerry’s reported income came from tax-exempt municipal bonds. They missed the point. But so did Kinsley.

The most serious question is not how little tax Mrs. Kerry paid on the income reported, but how she managed to report only $5.1 million of taxable income with a net worth of at least $750 million. On October 16, New York Times tax reporter David Cay Johnston noted that “even a modest 5 percent return [on $1 billion in assets] would have generated $50 million of income, 10 times what was on the two pages released by the Ms. Heinz Kerry. A statement released by the Kerry campaign noted that income taxes are paid directly by the Heinz family trust.” The Kerry campaign raised questions rather than answers, since it remains a well-guarded secret how much the family trust paid in taxes, or to Mrs. Kerry.

On October 21, The Journal printed a dozen letters on the relatively minor issue of tax-exempt interest income. One made the simple point that Kinsley now overemphasizes -- that income from tax-exempt bonds involves an “implicit tax,” because the pretax interest rate is lower than might be gotten on similar taxable bonds. It follows that the actual burden of driving investors into tax-exempt securities involves “deadweight loss” – a loss to taxpayers that exceeds by far the revenue gain (if any) to the government.

In a similar way, the pre-Bush tax rate of 39.6 percent on dividends had a high cost to me even though I never paid it. To avoid a high tax on dividends I invested too heavily in riskier securities that pay no dividend in the hope of capital gains. Before the capital gains tax was reduced in 1997, I bore yet another cost by parking cash in a tax-exempt bond fund. The lesson Kinsley should have learned from Mrs. Kerry’s example, if not from mine, is that high tax rates on avoidable transactions hurt taxpayers without yielding any revenue. But the lesson he draws, oddly enough, is that steep tax rates that are avoided are somehow superior to lower tax rates that are paid. “Teresa Kerry’s tax returns,” he writes, “certainly seem to illustrate, not contradict, the case for her husband’s tax proposal.” Huh?

Kinsley makes an unduly heroic “rough estimate” that she paid “a fraction under 30 percent.” But this hypothetical implicit tax is not an estimate of dollars received by the U.S. Treasury, but an estimate of the burden of tax distortions to one taxpayer. The 12.4 percent figure, by contrast, would be an entirely fair measure of how little revenue Mrs. Kerry contributed to financing the sorts of grandiose federal spending schemes her husband favors. It would be fair, that is, if her income was not understated.

The truly interesting question, however, is how Mrs. Kerry managed to report so little income. She made it into the Forbes 400 with a net worth of $750 million, most of which is presumably invested in H.J. Heinz Co. Heinz stock rose 10.8 percent last year, from $32.87 to $36.43, yet Mrs. Kerry reported only $14,412 of capital gains. To be as fair as possible, assume she sold no Heinz shares. But what about last year’s dividends of 27 cents a share?

Alan Sloan’s sources estimated that were it not for last year’s cut in the dividend tax to 15 percent, Mrs. Kerry would have paid around $918,000 in taxes rather than $628,000, saving $290,000. Johnston figures she saved $440,000. Take your pick. These figures raise more questions than they answer. How could a Heinz heiress own so few shares of H.J. Heinz? And if her wealth is not mainly from Heinz shares, what is it?

For simplification, assume H.J. Heinz stock accounts for virtually all of her dividend income. Sloan’s figures then imply a 20 percent increase in the dividend tax (from 15 to 35) on her assumed 1,450,000 shares would indeed raise her taxes by $290,000. The trouble is that 1.45 million shares at $35 a share accounts for little more than $50 million – less than 7 percent of her wealth. Johnston’s estimate likewise implies 2.2 million shares, only about 10 percent of her wealth. We are still left with the key question Johnston posed at the start: How could Mrs. Kerry’s report income of only $5.1 million, more than half of which was tax-exempt, if her net worth is $750 million?

Subtract the value of her five houses, $33 million, and that still leaves $717 million earning only $5.1 million – a literally unbelievable return of seven-tenths of one percent. Even Heinz stock and municipal bonds did much better than that.

Despite reporting almost no visible return on her wealth, Forbes nonetheless estimates Mrs. Kerry’s wealth increased by $200 million over the past two years. How is that possible? If she owns enough shares of Heinz to have such large unrealized capital gains, then why does she report so little taxable dividend income? Besides, Heinz stock was no higher at the end of 2003 than it was at the end of 2001, so where’s the gain?

Estimates that Mrs. Kerry would have paid an additional $290,000 -$440,000 if the tax on dividends had been 35 percent rather than 15 percent assumes people would report the same amount of dividend income regardless how dividends are taxed. This is called a static revenue estimate, which is a polite expression for claptrap. Prudent investors would quickly stop holding dividend-paying stocks outside of pension funds. And, like Mrs. Kerry, they would hold more municipal bonds.

Incidentally, the 28 percent Alternative Minimum Tax (AMT) accounted for more than half her tax bill, $326,000, even though tax-exempt bonds are not subject to the AMT, which is usually a sign of aggressive tax planning, to put it charitably.
Contrary to Mr. Kinsley, Mrs. Kerry’s tax returns make no case at all for the centerpiece of her husband’s tax schemes – raising the top tax rates to 36-39.6 percent. On the contrary, as Mr. Sloan noted, raising the top tax to 39.6 percent would not increase Mrs. Kerry’s taxes at all. Any increase in the regular tax on part of her income would be offset by a reduction in the 28 percent alternative minimum tax on the rest. Mrs. Kerry’s tax return illustrates one of many reasons why Mr. Kerry’s wicked tax rates would not raise nearly the booty he imagines -- even aside from the demoralizing impact on work and investment. Raising the top two tax rates would have literally zero impact on at least one of the 400 wealthiest Americans – Senator Kerry’s wife.

One thing that raising the top two marginal tax rates really would accomplish, however, is to make the Kerry family wealthier. It would greatly increase the demand for municipal bonds, driving up their price and generating a windfall capital gain for Mrs. Kerry.

Mr. Sloan concludes, “Heinz Kerry doesn’t seem to be playing any significant tax games.” Yet serious tax avoidance games among the rich and famous typically involve hiding income in seemingly impersonal legal entities such as trusts.

The massive gap between Mrs. Kerry’s huge and growing wealth and her relatively tiny reported income suggests her lawyers and accountants have done valiant work. In their loyal efforts to ignore Teresa Heinz Kerry’s mysterious missing money, apologists Sloan and Kinsley have been especially heroic.

--Alan Reynolds, Cato Institute

1 comment:

Anonymous said...

Thanks, Alan. I was wondering the same thing when I read the WSJ article. I couldn't follow all your fine points, but it doesn't take an financial guy to wonder what shenanigans might be going on with the billion-dollar heiress reporting $5mil in income. As with the SUV's and everything else about the Kerry's, what's good for the geese (us) is not neccessarily good for the ganders (them).