Despite the many areas of dispute among economists, virtually all of them would agree tax rates should not vary by occupation. In other words, we don’t want to see one tax rate for firefighters, a different tax rate for schoolteachers, and a third tax rate for bookkeepers. In principle, everyone who earns $50,000 a year should face the same rate, regardless of occupation.
Hence, most economists oppose special tax breaks for managers of private equity or hedge funds. Under their own interpretation of current law, these managers do not pay taxes on their compensation. While those of us who get regular paychecks have taxes directly deducted each month, hedge fund managers have gotten into the habit of plowing their $100 million compensation packages back into the their funds without paying any tax whatsoever. When they do eventually pull money out of the hedge fund, they typically claim it as a capital gain and pay tax at just a 15% rate.
Proposals before Congress (bills S. 1624 and H.R. 2834) would make fund managers subject to the same tax rules as everyone else. They would have to pay taxes on their income when they earn it, and it would be taxed at the same rate as normal labor income. Under these proposals, fund managers would typically pay a 35% tax rate on the bulk of their compensation.
If our government had not grown so incredibly corrupt, this one would be a no-brainer. We might want to subsidize some important jobs (albeit probably not with special tax rates) that don’t offer very high pay—for example, doctors in rural areas or inner-city schoolteachers. I doubt, however, that anyone would suggest the government initiate a policy of subsidizing hedge fund managers, some of whom already pocket $1 billion a year.
There is no "private equity tax loophole." Under current law, investment income is double-taxed: First, the company you’re invested in pays the 35% corporate income tax, and then you, the investor, pay a 15% capital gains and dividends tax on what little is left. This new scheme isn’t loophole-closing—it’s just the Congressional Democrat tax increase of the week.
One bill (S. 1624) would introduce a third tax bite for publicly traded, private equity partnerships. Not content with taxing the underlying investment at 35% and the partner who owns the investment at another 15%, this bill would tax the partnership itself at 35% on top of the other two. All told, there would be a combined triple-tax rate of 64%, up from today’s double-tax rate of 45%.
The other bill (H.R. 2834) would raise the tax rate of a private equity manager’s capital gains from 15% to 35%. This would raise the double-taxation of this "carried interest" from 45% to 58%.
Who does this affect? Not the rich, who can afford fancy tax lawyers. Millions of Americans with defined benefit pensions have their retirements wrapped up in private equity firms. Ditto for college endowments and philanthropic trusts. Hiking taxes on these investments will ruin the retirement, education, and charitable hopes of millions of Americans.
This is really a not-so-subtle attack by the Democrats on the 15% capital gains and dividends tax rate that has resulted in trillions of dollars in new shareholder wealth since 2003. By picking off investors a few at a time, they want to raise all capital gains and dividend taxes to 40% or higher.
Add this to the long list of Congressional Democrat tax hikes this year—energy, tobacco, and Americans abroad are also big targets. Savers and investors, beware: Next on the Democrat chopping block is your pension.Opinions and conclusions expressed in the BusinessWeek Debate Room do not necessarily reflect the views of BusinessWeek, BusinessWeek.com, or The McGraw-Hill Companies.
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