The Hedge Fund Loophole

For years managers of hedge funds or private equity funds, like Mitt Romney, have enjoyed a privileged federal tax rate on so-called “carried interest.” But that 15 percent rate, while legal, is also grossly unfair to virtually all other taxpayers. It is unfair because it allows these managers to enjoy a tax break on earnings that are treated as capital gains but are essentially wages. They are like wages because the business of private equity firms is tied directly to the investments of their clients; usually managers earn 20 or 30 percent of the client’s total gain. That percent, the “carried interest,” should rightly be taxed at the same rate as wages, salaries and bonuses, typically 25 percent or 35 percent. And the hedge fund tax loophole should be closed.

The lost revenues the federal government could recover by closing the loophole are significant. RJ Eskow claims that more than $4 billion a year could be raised from just the 25 richest hedge fund managers if they paid the same tax rates as others.In 10 years, that handful of people would have added $44 billion to the U.S. Treasury. Not to mention the thousands of other hedge fund managers who don’t happen to be at the top.

President Obama has repeatedly expressed a willingness to close this particular loophole. He would do the deed as part of a comprehensive tax reform. But Congress has stalled on that ambitious effort. Not only Republican opposition, but also that of some key Democrats, like Senator Chuck Schumer of New York, have protected the loophole.

Thanks to Mitt Romney’s admission that he probably pays a federal income tax of around 15 percent, a national spotlight has prominently exposed the loophole. Perhaps now it can be closed, without waiting for a broader reform bill. The American people, in poll after poll, favor closing it. Who in Congress will represent the people, propose a bill and deftly use the give-and-take required in Congress to see the bill become law? (If that single-issue tactic works, it ought to be used to end tax breaks for corporate jet owners and oil companies, as well, but that’s another blog.)

Meanwhile, the president does well to keep bringing up the loophole. For it exemplifies gross unfairness in the tax code and shows how some of the rich get richer effortlessly,at the expense of other workers, most of whom are much poorer than they.

Michael Bloomberg, a self-made billionaire in his third term as mayor of New York City, responded promptly to Romney’s admission. Mr. Bloomberg said he pays the highest rate of federal income tax, 35 percent, which is more than double the rate Mr. Romney pays. Virtually none of it is in “carried interest,” the mayor added. He has joined a small group of billionaires led by Warren Buffett and Bill Gates who support a fairer tax code. I mention these billionaires because raising issues of fairness like this has nothing to do with class warfare. Certainly, no one has accused Mr. Bloomberg or Mr. Buffett of inciting it.

Maybe public attention to fair taxation will encourage the president and some members of Congress to close the loophole at last. But a public clamor would be even more effective.