Carried interest: It’s one thing to make buyout and hedge fund bigwigs pay income rather than capital gains tax rates on fund holdings they get for nothing. But US lawmakers even want them to pay more taxes than bosses in other sectors when they sell the firms they built. It’s a stretch.
Democratic tax chieftains Sander Levin in the House and Max Baucus in the Senate want to crank up the tax rate on so-called carried interests. The fast part of the argument is based on fairness. Super-wealthy fund managers shouldn’t pay a lower tax rate than the underlings who fetch their dry cleaning. Managers’ carry income, the share they take of the return on investment in portfolios they run, is currently clipped at the long-term capital gains rate of 15 percent (likely to increase to 20 per cent in 2011). Legislation pushed by Levin and Baucus would move that rate towards what the rich pay on ordinary income — 35 per cent currently, and probably 40 per cent next year.
But in a burst of taxation innovation, the two lawmakers want to extend the principle. When an entrepreneur sells a slice of his business or takes it public, any profit on the transaction is traditionally taxed as a capital gain. This has been true whether the business is a private equity manager, an oil partnership or a hamburger joint. But Levin and Baucus want to single out financial investment partnerships — basically private equity and hedge fund shops — for special treatment. The gain in enterprise value and goodwill, including the value of a firm's brand and customer relationships, would be taxed as ordinary income.
The provision is so bizarre that some Washington tax mavens thought it a clerical error when they spotted it. Penalizing what amounts to entrepreneurial “sweat equity” would be a sea change in tax policy that calls for serious debate in its own right. It would also be unfair if applied to only one kind of business.
But cash-strapped governments will do strange things. Especially if they think they can get away with slipping them in along with more sensible-seeming measures, like higher taxes on the standard kind of carried interest. In this case, it’s not even as if the whole set of measures would raise that much for the government. Financiers may be unpopular, but that doesn’t make every new tax on them a good thing. It’s time for legislators to break out the erasers.
