THE STUDY JANUARY 17, 2012
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Under increasing pressure to divulge his income tax returns, Mitt Romney announced today that he’s “probably” taxed at a fifteen percent rate (he seems more certain of the amount of jobs Bain created). The number is significant. If Romney were a typical rich guy, he’d pay 35%—the top marginal rate—on most of his yearly income. But since he’s a private equity guy who still gets paychecks from Bain Capital, he’s taxed at 15%, the capital gains rate that the Bush tax cuts instituted. We’d be accused of inciting class warfare if we suggested private equity’s “carried-interest loophole” was somehow unfair. Instead, let’s just imagine the US has a long-term deficit problem and needs to raise additional revenue. How much money would the government bring in if it eliminated the loophole and taxed private equity managers at 35 percent?
The question is a complicated one in part because we can’t project how much private equity firms will invest, or what profits they’ll make from their investments (partners get a cut of each). Assuming they invest $200 billion in a given year, as UPenn Law School professor Michael Knoll did in a 2008 study, the amount of extra revenue brought in would total anywhere from $2-3 billion a year. (To contextualize, the Office of Management and Budget estimates that 2012 tax receipts will total $2.6 trillion.) Though Kroll’s figures are compatible with a 2007 report by the Joint Committee on Taxation ($2.4 billion per year) he included a caveat the JCT didn’t. By shrewdly changing the nature of their partnerships, private equity firms may be able to blunt the blow of the tax reform. For example, if the firm's investors make loans to partners rather than direct capital contributions, the firm’s return on those loans would be taxed again at 15 percent, not 35 percent. Or as Knoll puts it: “It is thus possible that there would be little or no net increase in tax collections from taxing carried interests as ordinary income.” What did you expect?
4 comments
No, that's not the issue. You and your brother in law form a joint venture to invest in real estate, he agrees to put up the money and you agree to find the real estate, and you and your brother in law agree to share profits 80/20, you taking 20% for your share, and your brother in law taking 80% for his share. When you sell the real estate at a profit, should your profit be taxed as capital gain at 15% or as ordinary income at 35%? "Carried interest" is a red herring. The issue is whether the "service" partner's share of profits should be taxed as capital gains or as ordinary income. This is an old battle in the tax wars, one that service partners won in large part because the alternative tax treatment is more complex than quantum mechanics.
- rayward
January 17, 2012 at 6:20pm
Well, the obvious answer (to me, at least), is why don't we just collapse the complicated taxation wave function and treat all income the same?
- hairdan
January 17, 2012 at 11:46pm
ray, both should be taxed at the same rate, (how the hell is anyone going to know who put in how much unless it were laid out in a contract) the only caveat I would have is that long term capital gains taxes be lower because things like inflation (and for things like real estate, school and property taxes) and not taken into account. I bought land in 87 and sold it last year, I made a nice profit but I had also been paying taxes on the land for more than 20 years, and if you factor in inflation my real rate of return was much lower. A lower tax rate for long term capital gains. As to your example, if a person is willing to forgo compensation for decades for work done (finding the land, as well as living with the possibility of getting paid nothing) I don't have an issue with paying less. But if people are just flipping real estate in one year let everyone pay the full rate. The goal of a lowered capital gains tax rate is to build long term for the economy things that are sustainable and not based on economic bubbles.
- blackton
January 18, 2012 at 10:45am
"For every complex problem there is an answer that is clear, simple, and wrong." (Generally attributed to H. L. Mencken.
- skahn
January 19, 2012 at 11:47pm