How Can You Get Romney's Tax Rate? (Hint: You Can't)

In the week since Mitt Romney released his tax returns, the media has been abuzz with debate over his career history, his method of compensation, his amazingly high income and his incredibly low tax rate. Amid all the chatter, many pundits -- among them, DailyFinance's Dan Caplinger -- have wondered why more people don't take advantage of the deliciously low capital gains, dividend and carried interest tax rates that Romney enjoys.

The answer, of course, is that most people can't -- at least not on a level large enough to make a difference in their finances.

To begin with, Romney's most controversial income tax break, carried interest, is only available to a few employees of hedge funds and private equity funds. It's difficult to determine how small this group is: Roberton Williams, a senior fellow at the nonpartisan Tax Policy Center, notes that carried interest is a subset of capital gains tax, and is not explicitly differentiated in U.S. federal tax documents -- which means there's no easy way to separate out its beneficiaries. That said, the financial services industry as a whole employs about 5.77 million people, or about 3% of all workers in the U.S. Of that 3% few, only a small fraction are eligible for carried interest earnings.

Cream for the Top 20%

But, as some commentators have noted, anybody can take advantage of the low capital gains and dividend tax rates, and many families do: According to the Tax Policy Center, about 16.4% of all taxpayers paid capital gains and dividend tax on some portion of their income in 2011.

These lucky taxpayers are spread across the economic spectrum, but, unsurprisingly, the percentages are heavily skewed toward the richest end: 45% of all people who paid capital gains and dividend taxes in 2011 were in the richest 20% of the population, while only 5% were in the lowest 20%. The middle 20% -- the middle-est of the middle class -- only makes up 15% of investors.

And less well-off investors aren't exactly getting rich off their capital gains and dividends: In 2011, investors in the bottom 20% of the population brought home an average of $1,504 from their investments. On the opposite end, those in the top 20% averaged $43,202. In this case, the middle 20% are effectively lumped in with their poor cousins: Those average middle-class investors claimed about $2,442 in investment and capital gains income.

Tip of the Pyramid

At the top of the heap, the numbers get even more skewed. Among the top 1% -- Occupy Wall Street's bete noir -- 86.2% of people reaped some form of investment income, and the amounts were hardly chicken feed -- an average of $362,682.

But even the 1% paled beside the 0.1%, the super-rich, whose entry point is $1.6 million. On average, 94.5% of this group got some portion of its money from investments. And these investments paid well: The average take in 2011 was $2,275,145.

Romney, by the way, made out superbly even on the 0.1% scale: He made $20.9 million in 2011, and most of it came from investments.

Why the Poor (And Middle Class) Don't Invest

It's worth asking why more middle and lower-quintile workers don't invest their money. After all, a 15% tax rate is far preferable to the higher percentages that most taxpayers pay, especially when one factors in the Social Security and Medicare taxes, neither of which are deducted from investment income.

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But investing isn't easy for people in the lower end of the economic spectrum. According to the Bureau of Labor Statistics, for the bottom two-thirds of the country, the average income is $31,718, and the average expenditures on necessities total $28,283. In other words, for two out of three families in America, after food, shelter, transportation, clothing, health care and insurance are paid for, there's only $3,345 left over to spend on things like education, entertainment, savings ... and, oh yes, investing.

By comparison, the average family in the top 5% brings home $228,585, and spends $101,247 on the same necessities. At the end of the year, this leaves them $127,338 -- more than 38 times as much -- to put into discretionary items like investing.

But even if these medium and lower-income families were able to scrape together some money to invest, they wouldn't have quite the same options as those on the higher end. Most hedge funds -- the investments with the highest rate of return -- require a minimum investment of $1 million. Setting aside $3,345 per year -- the entire non-necessity budget of the average lower and middle-class family -- this would take about 299 years to raise.

On the bright side, some venture capital funds have dropped their buy-in to $250,000, which means that a middle-income family could hope to take advantage after only about 75 years of socking away their pennies.

When critics raise questions about Mitt Romney's tax rate, the standard rejoinder is that these disagreements are based in class warfare, or at least in some sort of socialist wealth-redistribution scheme. These attacks aside, the question that Mitt Romney -- and his fellow tax-cut partisans -- need to answer is why the tax code already contains a massive tax break that really only benefits our wealthiest citizens.

Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at b