Here's why tax rates are varied

In his State of the Union speech Tuesday, President Barack Obama focused on equity and fairness in the current U.S. tax code.

WASHINGTON -- Why do Mitt Romney and other wealthy investors pay lower taxes on the income they make from investments than they would if they earned their millions from wages? Because Congress, through the tax code, has long treated investment more favorably than labor, seeing it as an engine for economic growth that benefits everyone.

President Barack Obama and the Occupy Wall Street movement are challenging that value system, raising volatile election-year issues of equity, fairness -- and Romney's tax returns.

Romney, who released his 2010 and 2011 tax returns this week, has been forced to defend the fact that he paid a tax rate of about 15 percent on an annual income of $21 million. His tax rate is comparable to the one paid by most middle-income families. His income, however, is 420 times higher than the typical U.S. household.

Romney's taxes were so low because the vast majority of his income came from investments. The U.S. has long had a progressive income tax, in which people who make more money pay taxes at a higher rate than those who make less.

For almost as long, the U.S. has taxed capital gains, the profit from selling an investment, at a lower rate than wages.

"There are two ways to look at. There is a moral argument and an economic growth argument, and they both point to lower taxes on capital gains," said William McBride, an economist at the conservative Tax Foundation.

McBride said it is unfair to tax income more than once, and capital gains are taxed multiple times. If you got the original investment from wages, that money was taxed. If the stock you own gains value because the company you invested in makes a profit, those profits are taxed through the corporate tax. And if that company issues dividends, those are taxed as well.

Lots of people are double- taxed, said Chuck Marr, director of federal tax policy for the liberal Center on Budget and Policy Priorities. "Check out your last pay stub. There's income tax and payroll tax, so you're double-taxed too," Marr said. And, he noted, when you buy something, you probably pay a sales tax.

Under current law, the top tax rate is 15 percent on qualified dividend and long-term capital gains, which are the profits from selling assets that have been held for at least a year. The top income tax rate on wages is 35 percent, though that applies only to taxable income above $388,350.

Congress started taxing capital gains at a lower rate than wages following World War I. The concern then was that high taxes on capital gains actually reduced revenue because people would simply hold onto their investments and restrict the flow of capital, according to the Encyclopedia of Taxation and Tax Policy.