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.






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7 years ago
"The lost revenues the federal government could recover"

Why would you call this "lost revenue".  Was this the government's money in the first place?
Jim McCrea
7 years ago
Joe:  the income advantage is the result of governmental acquiesance to outside lobbyists pressure to create this advantage for the few, the proud and the advantaged.

So, yes, some of this money should be the government's, i.e., the taxpayers whose taxes subsidize the lack of income from these sleazebags.
J Cosgrove
7 years ago
A couple things.  

First, is this how Romney made most of his money?  I thought he was doing it via leveraged buyouts and in a sense that is investment.  I may be entirely wrong on this but if anyone has better information, let me know.  I know there are several stories running around today about his current income which I am sure prompted the OP and that it may be due to this.  So let's get into a discussion if the loop hole should be fixed.  Sounds like maybe it should be changed but often the initial look is not clear.  But would it generate anything meaningful?  Doesn't sound like it but it might make some people feel better but provide zero new jobs,

Second, Paul Ryan proposed an extensive rewriting of the tax laws to get rid of certain loop holes.  Is this one of them?  Again I do not know but the OP said there was resistance to rewriting the tax code.  How true is that?  Might make a good discussion.

Finally, Bllomberg, Buffett and Gates can donate their money to the government any time they wish.  So far I believe the number is zero.
Joshua DeCuir
7 years ago
Below are 2 links to somewhat more even-balanced analysises of the carried interest rule and its implications.  The author of the first, Megan McArdle of The Atlantic, still sides with ending the rule (as do I), yet she also points out some of the nuances of why the rule was created in the first place.  She writes:

"There are arguments for an[d] against. The arguments for the carried interest are fairly compelling: without it, the partners who contributed ideas and talent end up being taxed much more heavily on their earnings than partners who contributed financial assets.  This is not only sort of unfair, and impedes the ability of talented people with few financial resources to move into the moneyed class, but also might have implications for economic growth: if your gains are going to be taxed at ordinary income rates, why quit that safe job and risk all on an untried venture?"  I also think her larger discussion about why making tax policy to correct one problem apart from more comprehensive reform is a healthy antidote to Ms. Smith's argument.

This link is to a very good discussion of why, precisely, capital income is taxed quite differently than other forms of income. Again, I think a legitimate debate must be had about these issues, but it helps to have actual knowledge to debate as opposed to just emotional reactions to what's fair or not.

Neither of these authors, nor The Atlantic, can be pegged as right-wing supply-side blowhards.

Finally, I'm mystified that the President chose to ignore the sage proposals in the Bowles-Simpson plan that would have gotten him a tax code more akin to his arguments.  I wish the America bloggers would at least acknowledge the failure of the President in that regard in their rush to denounce the GOP candidates, if for no other reason than wanting to avoid the appearance of being in Obama tank hook, line and sinker.
7 years ago

In fact I read an interview with Bill Gates where he said his billions to Education have been a failure and he will no longer donate money to schools.  Instead he will only donate money for research into new ways to educate since the current model is such a failure.

The last thing Bill Gates wants is to voluntarily give his money to the current education system.  But he is for someone threatening him with jail time unless he give more money to this system that he won't support voluntarily.  Go figure.
J Cosgrove
7 years ago

Bill Gates is a big fan of Salman Khan and so am I though Sal is starting to spout some PC ideas lately.  Sal might revolutionize education with his Khan Academy along with lots of modern technology.  My business requires that I understand some biology concepts and I found some of his videos better than any textbooks I read.

If anyone wants to understand money and banking and the economic origins of the housing crisis, he has some good videos though some of his other economic stuff at the time is now dated and betrays some political leanings.  

There was something last week about how Buffett milks the system and how he is just currying political cover with his stances.  By publicly siding with Obama he is getting cover and no scrutiny and possibly access to some sweetheart deals.  I much rather see his money go to charity than to the government.  We know who will probably use it more wisely.

And as an aside, there were comments last night that one of the reasons that Romney does not want to release his tax returns now is that he has contributed multi-millions to the Mormon Church and Mormon activities and it would start a whole new discussion about Mormonism and the presidency.  So by April, the fate of the nominee will be determined and cause less of an issue.  This may be the wrong insight and we will have to wait and see. 
Tom Maher
7 years ago
This article is a very flawed tax analysis.  Tax policy is not created exclusively out of theological,  phislosphical or political concerns of fairness.  Missing from this analysis is economic conerns and impacts.   Any change to ithe tax code has a huge potential for significant negative economic impacts.  Narrowly considered imposition of taxes have been known to kill off or greatly dismish whole industries. 

The economic context of any tax change must always be very carefully considered.  The power to tax is the power to destroy or impair important economic institutions needed for the growth and health of the nation's economy such as private equity investment.  Why destroy what is good and working so well out of ignorance of how the economy works and when everyone benefits from these economic insttuitons? 

The proper economic and legal context for the subject of "carried interest" tax polcy is partnership tax law.  Partnerships are not individuals and they are not corporations so they are taxed differently reflecting their unique nature that allows them to uniquely contibute to the nations economy.  It is not correct to think of partnerships as individuals performing services.  For example venture capital partnerships are exposed to hugh risks where many if not most of the new business they are trying to establsh will likely fail.  This partnership's hugh risks must be offset by a tax policy that makes allowances for these businesses to be involved with non-established business and  markets.  The economy benefits from the establshment of new business and new markets when these financial ancial partnerships succeed. 

It is not appropriate to tax partnershipz the same as individuals which is why partnership have always been taxed differently.  High risk venture capiltal parnerhsips need to be allowed to survive and expand to benefit the economy with new business, markets  and job creation.        
Joshua DeCuir
7 years ago
By the way, it seems likely (I suppose we'll know more after tomorrow) that the Carried interest rule isn't at play in Romney's 15% rate at all.  This post (from someone arguing in support of ending the carried interest rule) explains why:

"There is a difference between Romney's capital gains and mine. I suspect that his capital gains are mainly real gains on investments he made with his own money. Mine are mostly capital gains our firm has made with other people's money. This is the carried interest capital gains discussion. I've been loud and clear that I don't agree with the current policy on carried interest taxation and I hope that the law is changed on carried interest. It will cost our family a lot of money in increased taxes but it is the right thing to do."

Facts, facts, facts.


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