TALK BACK: Where Do YOU Stand on the Carried Interest Tax Debate?
Recently, the debate has been re-ignited over whether Congress should (or could) tax carried interest as capital gains instead of as regular income. VCs and private equity professionals said in a peHUB poll that they don’t believe President Obama will succeed in more than doubling the rate on carried interest from 15% to 35 percent. (See poll results here.)
We don’t want to debate the morality of tax codes (you know where to go for that). Instead, we want to debate the likelihood that carried interest will be taxed as capital gains and what the impact will be if such a change is made.
Some important questions for you to weigh in on:
- Can we successfully reduce our national debt by reigning in government spending alone, or is some tax increase necessary to reverse the country’s worsening fiscal situation?
- Would you be open to negotiating a tax rate on carried interest that’s higher than 15 percent in exchange for not being taken all the way up to the 35% threshold?
- Do you believe that increasing the rate would have substantially negative impact on VC and PE pros or do you agree with Cerberus’ Stephen Feinberg, who called himself and his colleagues “embarrassingly” overpaid earlier this year?
Let us know what you think below.
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TB said on July 12, 2011
The same people that continue to support the wars in Iraq and Afghanistan are the folks that refuse to pay for them. Yes, of course we need to raise taxes to pay for the debt the country is already in as we did during our previous wars. Our grandparents made sacrafices during WWII to pay for the US led victory and we should pay for the war on terror.
As for the carried interest debate, I think the PE and VC world has their heads in the sand. I don’t understand why you should be taxed at a capital gains rate when you have $0 of your own capital at risk! I believe that the GP portion of the invested capital should be taxed at the capital gains rate, but any LP capital that benefits the GP is income, period. And GPs should lock in a 35% rate now, because the highest tax rate is going to 40+%.
Jon R. said on July 12, 2011
The answer is quite simple: flat tax. An 18% tax rate on ALL income, regardless of source. Wages, dividends, long-term capital gains, short-term capital gains, etc. Ideally, corporate would be eliminated, but if not, reset it to 18%. Establish a standard, individual exemption of around $20,000 or so, index that to inflation, and tax everything above it at 18%. No deductions (elminiate all immediately, but phase out mortgage interest over 10-15 years), credits, loopholes, gimmicks, “tax expenditures,” etc. It is inherently progressive and eliminates the distortions, corruption and rent-seeking embedded in the tax code. If we have a clean tax code, politicians have fewer opportunities to wreak havoc with their social engineering and special interests have fewer opportunities to game the system. They are the losers under this scenario, while everyone else wins. Why 18%? Because that is roughly the percentage of GDP collected by the federal government in annual tax revenue, REGARDLESS of statutory rates. Let’s keep it simple and put all the bright minds wasting time creating efficient tax structures to better uses that can actually boost productivity.
Eric said on July 12, 2011
As anyone familiar with Subchapter K of the Internal Revenue Code (which deals with partnerships and LLCs) will acknowledge, the profound problem that taxing carried interest at ordinary income rates poses is a profound increase in cost of compliance and consequent dampening of investment activity by reason of the mammoth complexity of reverse engineering this result into the tax code.
Simply, the same relatively simple rules apply to every single investment partnership or LLC, whether it’s a family LLC that holds a three-flat or a multi-billion dollar hedge or private equity fund. One of the fundamental tenets of Subchapter K is that partners are free to allocate among themselves items of income, gain, loss, deduction, or credit in such a manner as they see fit. This flexibility has significantly fostered capital formation on a small and large scale across the country for decades.
The argument that the big guys can handle both the increased tax burden and the cost of compliance is debatable but arguably true if also cavalier. The real problem is the millions of smaller investment partnerships, and would-be partnerships that no longer will be formed, that would have the cost of complying with this new regulation skyrocket with no corresponding benefit except, perhaps, the feeling of satisfaction in some quarters of keeping perhaps a few hundred people from “getting away” with something. Very much anti-growth and anti-employment, killing the goose that is laying the golden eggs.
The more important question is whether a capital gains tax preference should exist in the first place because without this, the carried interest tax question does not exist. A far more pro-growth and pro-employment solution would be to eliminate the capital gains tax preference (perhaps also with a raft of other tax preferences, commonly referred to as “loopholes”) and lower tax rates overall. Permanent tax cuts are universally acknowledged to be stimulative, and wasteful compliance costs will be eliminated.
Jonathan Marino said on July 12, 2011
Here’s what it all comes down to: politics, politics, politics. It’s impossible to miss that unemployment is past the nationally-acceptable average, and the Obama Administration is limping into an election year in which it, and its Senate, will be taking blows on all sides. The House is already a foregone loss. Bi-partisan legislation to raise taxes on private equity will be tougher to hold together than the last round of a two-hour game of Jenga.
So far, Democrats have done what they can to stanch the bleeding in the economy and simultaneously prove to the American public some of the frauds that profited in the years leading up to the 2008 market crash were brought to justice. It’s certainly no coincidence that the Justice Department has been playing whack-a-mole with hedge fund frauds from Broadway to South St., and they’re not done working their way up the food chain. Translation: expect more charges. In the next 18 months, Americans will hear some variation of this message: “We know the economy’s hurting, and it isn’t good enough. We’ve worked to fix it, and this country would have fallen into shambles had you elected McCain, as it will be under Romney/Huntsman/Palin. But we’re busting bad guys from Wall St. to Pakistan, just look at our results, and look at what we’re doing still.â€
Democrats will eventually pitch a tax increase on carried interest—the weight of the federal deficit practically forces them. In the game of politics and passing legislation, there is no gray—only black and white—so carried interest taxation either will happen, or it won’t. It is doubtful lawmakers would offer up a discount to the income tax rate for carried interest when they do try to raise taxes on private equity.
One thing that goes in favor of PE pros is that the Obama Administration will have bigger fish to fry.
Did I mention it’s an election year? The more “evidence†the administration has stacked before its constituency that it has worked to rid the finance profession of the evils that steered our economy nose-first into the ground, the better its odds of winning a re-election campaign. This evidence, I expect, will come not in the form of a tax increase, but in the form of charges being levied against individuals at one or more of this country’s biggest investment banks for the market manipulation that led to the 2008 crash. It’s just a matter of time: they got Osama bin Laden, they got Whitey Bulger, and this trophy trifecta will look very good with a senior banker’s head on it. Or, a few… (dozen?).
Using the Justice Department as a political sledgehammer requires no consent of the opposition party, and it doesn’t do anything but make the Obama Administration look as if it is defending the American public. The GOP effectively turned the DOJ into its propaganda arm in 2008 when just one client’s number—that one infamously being #9—was leaked from a multi-target investigation, effectively terminating then NY Gov.-Eliot Spitzer’s once-promising career. Thing is, for the DOJ to make the Obama administration look good before an election, they don’t even need a conviction to pat themselves on the back—the only thing that needs to happen is charges being filed, and the obligatory perp walk for the cameras.
In short: rest easy, PE pros. You’re one of the tougher targets for lawmakers to hit.
Mark Boslet said on July 12, 2011
I have a hard time with this issue. On one hand we want to encourage investment. So treating carried interest as a capital gain makes sense. On the other hand, we want everyone to pay a fair, equivalent tax on their incomes. If this is a majority of a venture capitalist’s income, then perhaps it should be taxed as such.
David said on July 13, 2011
You can call it anything you like but in the end, it’s income and should be taxed as such. It’s a very big loophole for people who as a group, hardly need additional economic advantages.
GMS said on July 13, 2011
The issue has come up once a year at least for the last 2 decades and nothing has ever happened — We are very skeptical on any governments ability to do something the PE industry doesn’t like.
Carry tax has nothing to do with the investments, tax increases or innovation — those are red herrings that distract from the real issues. Capitalization structure whether fund or holding company has NOTHING to do with the core business of sourcing, adding value and exiting private investments.
We published blogs on this the last time the issue raised its head under “In defense of the equality of capitalization structures”. We feel that many don’t realize that the carry tax bias actually has a negative impact on early stage companies by forcing early exit that a fund structure requires. A holding company structure could allow baby companies the proper time to mature. Unfortunately thanks to the carry tax loophole, everyone wants to raise a fund…
1. In Defense of the Equality of Capitalization Part Deux https://www.aarmcorp.com/blog_posts/40
2. In Defense of the Equality of Capitalization Structures Part One
https://www.aarmcorp.com/blog_posts/26
This issue is about nothing other than understanding simple math and correcting perverse incentives in our tax structure.
brian flynn said on July 14, 2011
Expanding on Eric’s comment…
1. If you want to tax all cap gains from all options as ordinary income, then carry s/also be taxed the same way. Otherwise, not.
2. One alternative no one has ever proposed is to create a cap on carry not subject to ordinary income rates. Slippery slope, but it would allow Congress to go after the ‘fat cats’ who earn zillion-dollar carries while perpetuating the incentive for those less lucky. There are precedents for this in the code (e.g., limitation of $1mm on home mortgages) which is what makes the code so messy.