Carried Interest: Senate Getting Swayed by Lobbyists

by Linda Beale

Crossposted with Ataxingmatter

Carried Interest: Senate Getting Swayed by Lobbyists

The Senate started discussion of the “extenders” legislation on Tuesday. IN the House version, HR 4213, there is finally a carried interest provision, though it is a weak one. (Recall that carried interest is the amount that managers of hedge, equity and other partnerships charge for managing assets of the partnerships, so it is compensation income but these “profits” partners claim that their allocations of capital gains from sales of partnership assets should retain capital gain treatment as such allocations do to partners who have contributed capital to a partnership, even though it is a payment for the managers’ services. See earlier postings on A Taxing Matter, here and here (JCT reports) and here (Weisbach study). ) After several years of attempts to tax wealthy fund managers on their compensation the same way that others are taxed–i.e., at ordinary income rates–the House included a revenue offset provision in the extenders bill that will eventually tax 75% of the carried interest at ordinary income rates.

Lobbyists responded that they would work on the Senate to make the bill less distasteful to their clients. So they are lobbying for even lower rates in the Senate. And they are focusing on what they think will be a sympathetic case–family partnerships that run family real estate businesses. A substitute amendment is under consideration, which would change the percentages and grant even more favorable preferential treatment to fund managers for their compensation for services–65% generally, with an even more favorable 45-55 split if the assets are held by the partnership for at least seven years. Text of the substitute amendment, a summary and other information is available at the Senate Finance Committee website on HR 4213.

Just a few comments:

1) the purported economic justification for privileged treatment of fund managers–that there won’t be as much management of funds or funds that invest–is absurd. Fund managers were making money head over heels but still will make most of that money even if they pay taxes on their services income the same way ordinary folks do. They won’t stop acting as fund managers if they have to pay ordinary income rates on their income. There will not be any fewer funds if the managers don’t get the special privileged tax rates that they claim for carried interest. There won’t be any less investing activity. There won’t be any great harm to family partnerships or real estate partnerships or hedge funds or private equity funds. None of the managers of any of these funds merit the exceptionally lucrative tax break that they have been claiming in the carried interest mechanism, and none of them will receive so low a return that they will quit the business if they have to pay the same tax rates that ordinary Americans pay on their services income.

2) Any provision that splits the rate structure is arbitrary, makes the tax Code more complex, invites gamesmanship on holding periods, and will be passed only as a way to appease wealthy donors so that they will continue contributing lots of funds (that should have been paid to We the People as taxes) to individual House and Senate campaign chests of those that are holding out for a “softer” bill.

3) there is no justification whatsoever for a half-way measure in which fund managers are privileged to pay low rates on a substantial part of their income from services, while ordinary taxpayers continue to pay ordinary rates. That sort of “compromise” merely proves that the House and Senate are willing to sell out ordinary taxpayers and continue to favor the wealthy and that fairness loses when the House or Senate is thinking about campaign contributions. The split just proves the outsize influence that lobbyists for the shadow banking system still hold over Congress, even though the unregulated shadow banking system (including hedge and private equity funds and real estate partnerships) was a significant cause of the financial crisis.

4) Accordingly, the House compromise, and the Senate substitute, make a mockery of the basic fairness concept in taxation. The problem with carried interest is that it allows a few financial managers a preferential tax break on their compensation income. The entire Congress is now aware of the fairness problem. In spite of their awareness that there is no justification for the tax break that these wealthy fund managers have claimed for years, lobbyists for the privileged few who have enjoyed this tax break are pushing to retain the break. Since we know that the Senate and House understands that this is an unfair tax break that ordinary Americans do not enjoy and that cannot be justified in any way as a necessary tax expenditure to encourage an activity, then it must mean that the House and Senate are too corrupt to pass decent legislation that treats these wealthy fund managers like ordinary people.