Thursday, July 19, 2012

The Romney Family, Financial Engineering, and Rising Inequality

Jacob Weisberg at Slate:
Romney’s Bain career is a story about rising inequality. It’s telling that George Romney, Mitt’s father, made around $200,000 through most of the years he ran American Motors Corporation. Doing work that clearly created jobs, the elder Romney paid an effective tax rate that averaged 37 percent. His son made vastly more running a corporate chop shop in an industry that does not appear to create jobs overall. In 2010, Mitt Romney paid an effective tax rate of 13.9 percent on $21.7 million in investment income—around 14 times as much as his father in inflation-adjusted terms. This difference encapsulates the change from corporate titans who lived in the same world as the people who worked for them, in an America with real social mobility, to a financial overclass that makes its own separate rules and has choked off social mobility. The elder Romney wasn’t embarrassed to explain what he’d done as a businessman or to release his tax returns. . . .

It’s not clear that private equity—like other forms of financial innovation—is good for America. You’d think that if private equity made businesses more efficient and valuable overall, there’d be clear evidence to support it, but there isn’t. Private equity firms earn most of their money through financial engineering. A big share of their returns comes from “tax arbitrage”—figuring out how to exploit loopholes to pay less to the government. Because interest is a deductible business expense, debt financing means they often pay little or no corporate tax. Private equity’s reliance on leverage can also magnify short-term earnings without leaving the companies they manage more valuable overall. One legal but dubious practice that private equity firms engage in is paying large “special dividends” out of borrowed money. As Jim Surowiecki of the New Yorker has written, “These dividends created no economic value—they just redistributed money from the company to the private-equity investors.” 
When people say that attacking what Romney did at Bain is attacking "Capitalism," they are missing the point. Capitalism existed for centuries before anyone dreamed up the crazy financial schemes of 1980 to 2008. Those schemes depend on exploiting the details of laws governing taxes, pensions, corporate governance, and so on, and they also have nothing to do with making things that people want. They are not capitalism, but a sort of meta-capitalism that leeches vitality out of the real thing. If a way can be found to ban them we absolutely should. Everyone would be better off except a small class of financial vampires.

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