Opponents of Closing “Carried Interest” Loophole Actually Make Opposite Case
http://www.offthechartsblog.org/opponents-of-closing-%e2%80%9ccarried-interest%e2%80%9d-loophole-actually-make-opposite-case/
Posted by: Chuck Marr
Posted in: Businesses, Federal Tax
Policymakers would be well-advised to read a new Tax Notes piece by Douglas Holtz-Eakin, Cameron Smith, and Winston Stoody, which argues against closing a tax loophole that enables investment fund managers to pay taxes on their income – their “carried interest” – at the preferential capital gains rate rather than ordinary income tax rates.
Ironically, the authors actually make a persuasive case for doing just the opposite of what they propose – that is, for closing this loophole, as Congress would partly do under a pending compromise proposal.
Specifically, policymakers should:
Ponder the main point of this article:
“Perhaps most damaging, the higher taxes on carried interest will re-allocate managerial talent, as the entrepreneurially-inclined are deterred by these higher taxes and seek their outlets elsewhere in the economy.”
That begs the obvious question: Should the tax code, as it now does through the carried interest loophole, encourage the best and brightest to become private equity managers or real estate developers as opposed to, say, scientists, engineers, or brain surgeons? We think not. The compensation of private equity managers should be taxed just like the compensation of all of these other important callings.
And heed its warning:
The authors do an important service when they highlight that these sophisticated financial players will “re-structure their investment vehicles so that the overall impact of the new tax on carried interests can be minimized or avoided altogether.” That’s a warning to policymakers to make sure that whatever proposal they enact is drafted as tightly as possible so that financial players cannot circumvent its intent.
More About Chuck Marr
Chuck Marr is the Director of Federal Tax Policy at the Center on Budget and Policy Priorities.
Full bio | Blog Archive | Research archive at CBPP.org
Another argument being made is that increasing taxes will mean less investment. But that argument may also prove the case for increasing taxes because it draws a line between what managers are paid and investment, a link that is tenuous at best. For example, let’s assume managers pay more in tax, meaning they make less. They may try to change terms so investors make less, which then would rationally mean less investment in their funds. Funds do exist in a marketplace and if terms are radically worse for investment then money will flow to other funds, meaning the managers would then likely make less by demanding more. Or managers might respond by trying to raise more funds or perhaps by making more investments or by timing them differently or by looking for investments that have specific exit strategies. Some of these effects would increase the amount invested and others might change investments somehow in complicated ways we don’t know up front, but there is no real argument that there would be less investment. In normal markets, if you cut some return then the participants try to find ways to make it up. There are two rather obvious choices, but only one is highlighted by the funds industry. The two are that you try to change terms, even though that makes investing in your funds less attractive, or that you try to do more with the money, even getting more money, to make more. In other words, the tax could be an incentive, not a deterrent.