THE STUMP MARCH 5, 2012
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It has been apparent for a while now that Mitt Romney’s candidacy is less than ideal for the one percent, or the one-tenth or one-hundredth of the one percent. It is one thing to have a candidate who is committed to promoting unjust tax policies that will help you and your fellow millionaires; it is another thing to have a candidate who benefits from those unjust policies, thus making himself a poster child for reform. Romney pays a federal income tax rate of only 14 percent on his income of more than $20 million per year because of two features of the tax code. First, capital gains on investments, the bulk of his income, are taxed at only 15 percent, well below the top marginal rate of 35 percent for ordinary income. Second, the income he still collects from Bain Capital, as part of his retirement deal there, is eligible for the carried-interest loophole, which allows fund managers to have their compensation for investing other people's money taxed as capital gains, not earned income.
The carried-interest loophole, aka the hedge fund loophole, has been hanging on for dear life for a while now, protected by Wall Street friends like Eric Cantor, who has raised more from the securities and real estate industry than any congressman in recent years, and fought to keep the loophole off the table in last year’s debt ceiling showdown. But fewer and fewer people are willing to defend it. Pete Peterson, who benefited hugely from the loophole while running Blackstone, has come out for closing it, and I was stunned, in the days after Romney’s tax rate became an issue, to see even Stephen Moore, the Wall Street Journal’s ardent supply-sider, admit on TV that it was time for the loophole to go.
But lo and behold, what did I see tucked inside the business section of Sunday’s New York Times but an earnest effort to justify the loophole penned by Harvard economist Greg Mankiw. Mankiw is a veteran of George W. Bush’s administration. He is also one of the lead economic advisers to...Mitt Romney. And writing in the Times, he did an impressive job of muddying the water around a question that truly is as as clear-cut as they come: why should investment managers have the compensation for their labor taxed at a far lower rate than all other professionals? You’ll have to read it to believe it, but Mankiw’s trick is to bring in the more sympathetic example of a carpenter who teams up with an investor on a real estate project that turns a profit. Under current law, the carpenter’s share of the profits are taxed as capital gains, just as the investor’s are, even though in the carpenter’s case what he was putting into the project was his sweat equity, not an investment stake. If the carried interest loophole were closed, notes Mankiw, the carpenter would be taxed at a far higher rate than the investor he teamed up with. Well, yes—but that's only because we tax capital gains at a much lower rate than ordinary income. If Mankiw is so bothered by the carpenter’s fate after the closing of the carried interest loophole, then he should be pushing for the equalization of the tax rate for investments and earned income.
For now, though, it is clear that all the investment managers out there can rest easy: it looks like Team Romney will not let his personal stake in the matter keep it from arguing vociferously for maintaining the carried-interest loophole. And for the rest of us, it looks like we better get ready for many comparisons of the plight of Mitt Romney and other multi-millionaire money managers to the plight of a humble carpenter. Next thing you know, Romney might start putting nails in his mouth and spitting them out, pointy end forward.
*Update at 11 a.m.: Well, it looks like Mankiw’s defense of carried interest is even more eye-opening than I realized: Matt O'Brien, a former TNR intern now at the Atlantic, notes that Mankiw came out for closing the loophole back in 2007, when he used a rather different analogy in writing on his blog:
Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such. Paul Krugman hit the nail on the head with this question: ‘why does Henry Kravis pay a lower tax rate on his management fees than I pay on my book royalties?’
The analogy is a good one. In both cases, a person (investment manager, author) is putting in effort today for a risky return at some point in the future. The tax treatment should be the same in the two cases.
What to make of this? O’Brien, tweeting @ObsoleteDogma, suggests: “Whole point of the NYT piece was obfuscation. I’m not sure Mankiw has changed his mind. He’s just not saying now.” Or who knows: maybe, like Rick Santorum, Mankiw is just getting ready to “take one for the team.”
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7 comments
If the justification for the lower capital gains tax is that it encourages people with capital to invest and take risks with that capital - which is by far the most common justification one hears - then Mankiw's whole article is a smokescreen. Those who risk no capital should not get a break. Now, from my point of view, that justification is BS - we all earn our way with the tools we've got. For some that's our backs, others our brains, others still have money with which to make more money. We all invest our resources and take risks - think of the risk a young person who decides to become a physician takes and the years spent getting an education and accumulating debt, with no guarantee they will every be successful. Let's give them a 15% rate. Or think of the immigrant, who invests every dime and every fiber of their being at great risk to join a new society and culture. Let me be the first to suggest a 10% top tax rate for all immigrants, with a bonus for those here against the law, since their risk is proportionally higher. Indeed, let's reserve the "high" tax rates for people who invest nothing and take no risks - maybe those who decide at an early age that flipping burgers is their idea of a lifetime well spent. Truth be told, these people arguing for the "special" status of what they do make me ill.
- IowaBeauty
March 5, 2012 at 12:09pm
Mankiw may have been addressing the timing of the income, not its character, in his 2007 blog post; his blog post is a little confusing, and he does say that "I don't pretend to be an expert on tax law". I read Mankiw's piece in Saturday's NYT (it was posted Saturday on-line), and it too is a little confusing. But he does preface his examples (including the one Noah refers to) with a defense of preferential treatment of capital gains, in particular the actual historical reason, which is that capital gains are only taxed when "realized" (which many (me included) believe is a constitutional requirement) and, therefore, all the gain, which may have accrued over many years, is bunched into one taxable year and subject to potentially very high tax rates under our (at one time anyway) progressive income tax system; to his credit, he doesn't rely so much on the tired rationale that it promotes investment and growth. His larger point, that if the carpenter and moneybags who bank-rolls him should receive capital gains treatment, then so should the partners at Bain. And Mankiw is right, even if "equity" (it's the term tax lawyers use for taxing similar transactions in the same manner) is being turned on its head. In his 2007 blog post Mankiw goes on a detour and considers taxing the "initial value" of the "carried interest" (the correct term is "profits interest" for those who want to be accurate), referring to a "hedge fund manager" who supports this approach. Actually, the IRS once took the position that the receipt of a profits interest is taxable on receipt based on its FMV, but abandoned that approach once the complexities of enforcing it became apparent; and they are incredibly complex, because if section 721 of the IRC doesn't apply to the recipient of the profits interest, it doesn't apply to the partnership either, resulting in the partnership having to recognize (a tax term) a portion of its unrealized profits on its underlying assets even though the partnership hasn't actually sold any of the assets.
- rayward
March 5, 2012 at 12:11pm
That is "receipt of a profits interest" in return for services (i.e., the carpenter and the partners at Bain who perform services for the partnership as their contribution to it).
- rayward
March 5, 2012 at 12:26pm
When I read the article, I thought that Mankiw made a great case for keeping rates the same for all activity. If you have to ask what rate to apply to which activity, and when it is not even clear what the right answer is, then the best outcome is one where the rates are all the same.
- SJ_LEX_LEO@YAHOO.COM
March 5, 2012 at 1:40pm
Ray, I don't buy the timing argument either. I have, for example, paid ordinary income tax rates on vesting of stock options, making my income some years 3 or 4 times my usual salary. If you want have a leveling mechanism for stochastic income, fine. But make it a leveling mechanism, not a discount.
- IowaBeauty
March 5, 2012 at 2:25pm
I think we need to call the lower capital gains/dividends tax rate "discriminatory taxation" that is anti free market. And we need to call Romney a scumbucket for advocating anything in a leadership capacity that significantly benefits himself or his family at the expense of cutting down the safety net, increasing the national debt that everyone else and their children have to pay, or weakening the federal government so it can't respond to greater income inequalities after the next free fall on Wall Street.
- Nusholtz
March 5, 2012 at 4:05pm
IB, the taxation of non-qualified (non-statutory) stock options is a good comparison. For the uninitiated, someone who exercises one of those options realizes ordinary income (as opposed to capital gain) upon exercise of the option, even though he hasn't sold anything and, indeed, may be prohibited from selling the stock acquired in the exercise of the option, the income measured by the difference between the FMV of the stock at the time of exercise and the option price. And here's the flip side: the company gets a tax deduction in the same amount, even though the company hasn't spent any cash. For companies like Apple, it's an enormous tax deduction that doesn't reduce cash, and a big reason why many tech companies today have so little in net income subject to corporate income tax. Good day.
- rayward
March 5, 2012 at 5:55pm