JONATHAN CHAIT JULY 18, 2011
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[Guest post by Matthew Zeitlin]
An under-remarked upon aspect of the debt ceiling debate is the so-called “carried interest” loophole. The way this works is that the managers of a private equity, hedge, venture capital, or private real estate fund pay the capital gains rate on the income they accrue from the profits of an investment, even from the money that other people or organizations or people put into the fund. Typically, the fee structure for an investment fund is “two and twenty,” so that, if Jonathan Chait gives me $100 and I then produce a 100 percent return on this $100, I, the investment manager, would get $2 for managing the fund and then $20 of “carried interest” on the gains of the fund. On the $20, I would then pay the capital gains rate, not the income rate, even though it is not my own capital—it is my management of other people’s—that is generating the investment gains (investment managers also contribute to these funds in order to have “skin in the game,” though that’s immaterial to the carried-interest question). At one point, it seems, the White House supporting treating carried interest as normal income as part of a debt ceiling deal.
By way of Ben Smith (who describes the carried-interest tax treatment as capital gains rates on “bonuses,” which does not strike me as quite right) comes the not-exactly-surprising news that two House Democrats, Mike Quigley and Jared Polis, have come out against adjusting the taxation of carried interest so that it is taxed at the normal income rate instead of the capital gains rate. Putting aside the policy merits, it is hard to imagine a worse representative for the Democratic opposition to adjusting carried-interest taxation than Jared Polis. That’s because he’s incredibly rich. According to 2009 data from the Center for Responsive Politics (CPR), his net worth is somewhere between $36 million and $285 million. Moreover, over Polis’s career, three of the top-five sources of donations have been “Securities & Investment,” what the CPR calls “Miscellaneous Finance” and “Real Estate,” all of which are affected by the capital gains treatment for carried interest.
Not only does it seem as though Polis is protecting his contributors; it also seems he is an incredibly rich individual going out of his way to protect other incredibly rich individuals. For example, according to research done by Steven Kaplan and Joshua Rauh, “the top 25 individual hedge fund managers in the U.S. earned a combined total of $5.2 billion, $6.3 billion and over $9 billion, respectively, in 2003, 2004 and 2005”and that “nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined.”
There may very well be good reasons to tax carried interest at the capital gains rate, but Jared Polis’s open support for maintaining the tax preference sure looks like protecting his own.
7 comments
Actually, it's called "ordinary" income, not "normal" income. It seems like a long time ago (in a land long forgotten?), that the IRS wanted to tax the hedge fund manager (during the day, it was the real estate promoter) on the receipt of the 20% income profits interest; under section 83, the receipt of property (the income profits interest) for services is "ordinary" income. Well, that position has been abondoned (why?). Then the next issue is whether the "investment" in stocks (or whatever) isn't an investment but rather "inventory", so that its sale generates ordinary income rather than capital gains. For example, when Sears sells its inventory of goods, it's definitely not capital gains. The issue is whether the hedge fund manager is holding the investment (in stocks or whatever) for invesment (like one would hold real estate over the long term) or for sale (as Sears holds its merchandise for sale to customers). Like I said, the more persuasive case is that the receipt of the profits interest is income, ordinary income. It seems hard to believe today, but the IRS used to go after real estate promoters for failing to report the receipt of the profits interest in a real estate venture as ordinary income. Of course, the real esate promoters were small fries. The hedge fund operators? I don' think so. You think that might make a difference?
- rayward
July 18, 2011 at 7:41pm
Can we perhaps get Jared Polis to switch parties?
- liberalref
July 18, 2011 at 8:58pm
So why is it this man's "work" more valuable than, say, a scientist who is working in cancer research or trying to find new forms of energy? Or a construction worker building roads? Or a waitress or the garbage collector? The tax code says that his work is more valuable since he's taxed at a lower rate. I'd like to tax these cretins of finance at 2x the rate of the rest of us for the havoc and destruction they wrought, not 1/2 the rate us rabble pay. They don't provide anything outside of skimming off the top. "Money for nothing" indeed. There's your class warfare, brought to us by a DINO. Feh. Lib's right, switch parties and be honest about it you cretin.
- tmmats
July 18, 2011 at 10:37pm
"In fact, the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined.” Class warfare, plain as day. And they want lower taxes. Where are the pitchforks instead?
- tmmats
July 18, 2011 at 10:38pm
Let me get this straight: Polis is "incredibly rich," so there's the implication that he's protecting himself. But if he could easily self-fund his campaign, why the implication that he's protecting his campaign contributors too? How does that make sense? I agree that the "carried interest" rule is indefensible. Yet it has its defenders. Maybe Polis really believes in it. Steve Forbes supports a "flat" tax, but so do a lot of lower-income people, so maybe it's about more than self-interest. There's considerable support for eliminating the estate tax even though very few people are subjected to it. Should those who would be subjected to it then be derided for their position? I'd prefer to discuss issues on the merits rather than speculate about motives.
- dsimon
July 19, 2011 at 7:50am
sorry, dsimon. I can appreciate what you are trying to say, but like it or not, he is looking out for his own interests in this case. there's no question of motive or not-motive; he and his campaign's contributors stand to lose a lot of money if their taxes go up. as for the campaign financing, why spend your own money when you can have your friends spend theirs and write it off of their taxes? Your friends have more skin in the game, and you have more of your own money in your own pocket.
- GSpinks
July 19, 2011 at 10:53am
GSpinks: How do we know that Polis is just looking out for his own interests? It's an inference, but hardly proof. And regarding his donors, why would such a wealthy person have any compelling motivation to look out for anyone else's interests, much less his donors? Wealth means independence, so he doesn't need donors. Maybe he's looking out for his friends and his friends happen to be donors, but he wouldn't need them to keep his job. Is the implication that someone who is worth between $36 million and $285 million can be bought by a series of $5,000 donations--the most that can be contributed to a candidate by an individual? I find that hard to believe, especially if he's at the upper end of that range, which we don't know. (Campaign contributions to candidates are not tax deductible, so his contributors don't get to write it off their taxes.) And, getting back to the article, hedge fund managers make and obscene and unjustifiable amount of money. But there's no claim that they've made donations to Polis (who, the article implies, wouldn't need their money anyway). I don't blame people for being suspicious. Not at all. But I think an article making these claims should have a lot more substance to back it up. (To be fair, the article does say it "sure looks like protecting his own," but I don't think using the term "looks like" really makes the article a substantive one.)
- dsimon
July 19, 2011 at 12:06pm