The debt negotiations raging on in Washington have given Democrats a rare chance to do two of their favorite things at once: (1) Blame straw men for the problem, and (2) Declare class warfare and bloviate about the need for higher taxes on “the rich.”
In their desperate effort to find a way to increase revenue without having to make real spending cuts, Congressional Democrats are mining the tax code for quick fixes. Now, there are some things they could do that would make sense, like tackling federal subsidies and tax credits that involve the government picking winners and losers in the private sector, but those actions would make too much sense and could hurt them politically. So, they are regurgitating a previously failed idea that would do severe damage to the U.S. economy under the guise of “closing a loophole.”
Carried interest refers to the share of investment profits allocated to the manager of a private equity fund. Carried interest is not the manager’s primary compensation for managing the fund; rather it is an additional, investment-based sum, which the tax code classifies as a capital gain. Capital gains are taxed at a lower rate of 15 percent, as they are the fruit of risk-laden investments and not primary sources of income.
Liberals in Congress, realizing that ‘investment fund managers’ are not a very sympathetic-sounding group to the majority of Americans, have sensed an opportunity to paint a straightforward part of the tax code as a loophole benefiting the afore-mentioned evil straw men.
As American Enterprise Institute scholar Alan Viard writes:
Another questionable proposal would apply ordinary income tax rates, rather than capital gains rates, to carried interest received by managers of private equity and similar funds, even when the carried interest is an allocation of the fund’s capital gains income. Kevin Hassett and I have noted here (and again) that, despite the claims of the proposal’s supporters, the current tax treatment of carried interest is an application of general partnership tax law principles rather than a special preference for these funds. Some versions of the proposal take the even more dubious step of applying ordinary tax rates to capital gains earned by the founders of the firms that sponsor these funds.
It never ceases to amaze how, even with half a century’s worth of opportunities to observe the failure of socialist-styled class warfare-driven policies, liberals still cannot grasp this simple, founding principle of a free-market economy: Work has to pay, and hard work has to pay more, in order to incentivize people to get things done. Chipping away at that incentive merely to score some short-term populist points is the sort of unsound fiscal policy that produces diminishing returns. Investment is an engine that fuels our economy. If investment returns are taxed so heavily as to make them essentially worthless, than what’s the point?
And just to be clear, raising taxes on carried interest won’t just stick it to those wicked Wall Street fat cats (who happen to invest in thousands of small businesses). It will also destroy small real estate partnerships, as well.
With all the parallels that have been drawn between the economic recession of the last several years and the Great Depression, one would think that driving Americans to hide money under the mattress would be one similarity Congress would want to avoid.