Hiking Carried Interest Tax Is A Liberal Dream

Andrew F. Quinlan President, Center for Freedom and Prosperity
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White House staff recently indicated that President Trump still thinks raising taxes on carried interest is a good idea. On that he can find a lot of agreement—from big government liberals. If nothing else, perhaps the fact that only tax-warfare loving Democrats seem to agree with him on the issue will provide sufficient cause for him to reconsider.

Sen. Tammy Baldwin (D-WI) and Rep. Sander Levin (D-MI) recently reintroduced their respective  legislation to raise taxes on carried interest. They claim the bills close a “loophole,” but that’s a misleading excuse for what really amounts to a first step toward a long-sought goal of the left: raising taxes on all capital.

Carried interest is the name for the share of a fund’s gain that is distributed to its manager. Critics typically refer to hedge funds when discussing carried interest in order to maximize the class-warfare impact, but it also applies to private equity and venture capital funds, both of which play a vital role in growing the economy by funding entrepreneurship. Investors in these funds don’t just include wealthy individuals, but also endowments and pension funds, who all have a stake in the good performance of these investments.

These funds are typically organized as partnerships, which simply means that the profits and losses are passed on to the partners who then pay taxes as individuals at the appropriate rate. If the income represents a short-term gain they pay the ordinary income tax rate, but if it’s a long-term gain they pay the discounted rate for long-term capital gains. That the fund manager appropriately pays the capital gains rate on income derived from long-term capital gains is the sum total of the supposed “loophole.”

The capital gains rate itself is set lower for good reason. Capital is the lifeblood of the economy, so taxes on capital are especially destructive. Yet the tax code as currently structured taxes capital multiple times, as corporate income, capital gains, dividends, and even on death.

It would also be unfair to treat income derived from the same source differently according to which partner receives it. Like investors, a fund manager compensated through carried interest (as opposed to  or alongside a flat fee taxed as ordinary income) only benefits when there is a sufficiently high return. The desire to encourage such risk taking and increase investment in the economy is another reason for keeping capital taxes low.

So if anything there’s a strong economic case that the capital gains rate should really be zero.

Unfortunately, Democrats wish for the opposite. Rather than doing what’s best for the economy, they prefer to do what’s best for big government politicians ever hungry for more “revenue.” And the perceived unfairness of a lower capital gains rate makes for easy demagoguing to gin up public outrage and support calls for damaging tax increases.

They understand the value of incrementalism, however. Raising taxes on all capital gains is impossible in the current political environment. Chipping away at definitions to slowly accomplish the same goal is more practical. That’s why the list of co-sponsors for the Baldwin and Levin bills read like a who’s who of big government liberals, including Al Franken, Keith Ellison, Sheldon Whitehouse, and Elizabeth Warren, among others. The one exception is Joe Manchin, a more conservative Democrat who must not have realized the company he is keeping.

These Democrats are already crowing after Republicans opted to increase spending, even on domestic programs, in the recent bill to keep the government funded through the end of the fiscal year. They are also pleased with the dysfunction surrounding efforts to repeal Obamacare. Does President Trump really want to add a win on taxes and class warfare to that list?