Mitt Romney is basing his presidential campaign largely on his success as a businessman, building Bain Capital into a leading private equity company. While it is questionable how much success in business prepares a person for success in the White House (Herbert Hoover was the last president with notable success as a businessman), it is important to understand that Romney is not a successful businessman in the same way as others who have built successful companies.
There are many prominent business people who devoted their lives to building up large companies that produced tangible products, or provided services that had considerable value. Steve Jobs' name would be the first on anyone's list. Bill Gates deserves credit for Microsoft's growth. And in an earlier era, we can point to people like Henry Ford, Andrew Carnegie, who started the forerunner to U.S. Steel , and John D. Rockefeller, who began Standard Oil, the foundation of today's US-based oil industry.
None of these people were saints. Ford, Carnegie and Rockefeller had no qualms about violently suppressing workers' efforts to form unions. Rockefeller and Gates virtually wrote the textbook on monopolistic practices. And Apple is almost as well-known for its creative tax avoidance strategies, as its innovative products.
But each of these people could take credit for building companies that produced wealth. That is not the case with Mitt Romney.
Private equity companies like Bain Capital are not primarily about producing wealth. They profit largely by siphoning off wealth created elsewhere in the economy. There are many different ways in which this diversion of wealth is accomplished.
The simplest and most common trick is gaming the tax code. It is absolutely standard practice for private equity firms to immediately load up the companies they acquire with debt. This has two benefits for the PE companies. First, it allows them to get most of their money back right away. They end up with a heavily leveraged company, where the PE company is still in control, but has little of its own money at risk.
The other benefit is that the interest on the debt, unlike dividends paid out to shareholders, is tax deductible. This means that even if the PE company does nothing to improve the operations of a company it acquires, it will increase its profitability by reducing its taxes.
Of course PE companies like Bain are likely to have more sophisticated tax avoidance strategies as well. As Romney said in a recent campaign speech, big companies know the tax tricks, small companies often are stuck paying the taxes they owe. This means there can be big profits by acquiring smaller companies and teaching them how to game the tax code.
It's not just the tax code that PE companies game. By loading up the companies they acquire with debt, PE firms like Bain make them much more vulnerable to bankruptcy. While the creditors who lent the acquired company money presumably understood the risk, there are often many inadvertent creditors - such as suppliers, landlords and even workers, through their pensions. (The debt is always held by the acquired company, not by Bain, which carries no risk beyond its limited investment.) If a Bain-owned company goes under, these inadvertent creditors can take big losses. In the case of pensions, part of the loss will come back to the taxpayer through the Pension Benefit Guaranty Corporation.
PE companies like Bain also profit by breaking implicit promises made by the companies they acquire. There are numerous cases around the country where state and local governments have made concessions to local businesses in the form of tax breaks, land sales, infrastructure improvements and sometimes even industry-specific training in public schools in order to keep a firm located in the area. Many small businesses would be reluctant to renege on their side of the bargain and shutdown a factory. PE firms like Bain, don't feel bound in the same way.
Similarly, there is often a sense of reciprocity between workers and employers, where workers understand that if they work hard in their younger years and acquire firm-specific skills, their employer will keep them on the payroll in their older years when they may not be as productive. This can be a profitable long-term strategy. However, a PE company like Bain, that doesn't care about the long-term, can break the second half of this deal for sizable short-term profits. (My colleague Eileen Appelbaum has a fuller discussion of the ways in which private equity firms earn above-normal profits, here.)
In short, Bain Capital is not about producing wealth, but rather about siphoning off wealth that was produced elsewhere in the economy. There is no doubt that one individual or one company can get enormously wealthy if they are able to do this successfully. However you cannot have an entire economy that is premised on the idea that it will siphon off wealth produced elsewhere. It is not clear that Romney understands that fact, but certainly the general public should when it goes to vote this fall.