where have we heard this before?

Today NPR ran a story about a bill before the Senate that would close a controversial tax loophole. Investment fund managers, ranging from hedge funds to real estate funds, can structure their income–”carried interest income”–to be paid at the long term capital gains rate of 15%, instead of the top income tax rate of 35%. This is not always the case, particularly for hedge fund managers, because if the income comes from investments that are traded frequently then the fees are taxed at higher, short term rates. But it is very often the case of real estate development, where the turnover of underlying assets is much more likely to take longer than a year and therefore qualify for the long term, lower tax rate.

By requiring parity in the tax rates, NPR and Professor Len Burman project that the government could stand to gain almost $25 billion in additional taxes over ten years. Eliminating the differential would also reduce the likelihood that such very high income earners actually pay less taxes than regular employees. But of course the proposed change is meeting fierce resistance. The hedge fund industry argues that its managers mostly pay at the higher rate anyway (which of course raises the question why they would object to the change). The real estate industry argues that the change would jeopardize the employment of construction workers and others in the real estate industry. The industry also asserts that the US has always rewarded risk takers and that tax parity would penalize risk taking.

A call for continued social subsidies to promote entrepreneurial risk taking is odd, to say the least, coming from an industry that often touts free enterprise as the American Way. But perhaps much more important in the larger scheme of things, this seeming side battle is actually very relevant to the overall public policy debate about adequate financial reform: as conservatives have vehemently argued, public policies promoting unaffordable home ownership helped contribute to the financial crisis, and one might have thought that continued tax subsidization of new construction and real estate development would only make the situation worse.

Today’s comment by Lex in the Financial Times, though referring to the specifics of Ireland’s financial crisis, seems particularly apposite:

A profligate government in thrall to out-of-control property developers lavishes incentives on the construction industry to keep tax revenues flowing. Clueless banks raid wholesale markets for funds, and drop lending standards as the cash is pushed towards those favoured developers. Deferential regulators merely look on. That, in a nutshell, is how the seeds of Ireland’s financial crisis – the most severe of any country outside Iceland – were sown between 2003 and 2008.

3 comments for “where have we heard this before?

  1. Tom
    June 14, 2010 at 3:19 pm

    Tax Policy best described by Regan: If it moves tax it, if it keeps moving regulate, and if it stops moving, subsidize it. The effects of this proposed change in carried interest will be particularly onerous on the venture community. National Venture Capital Association (www.nvca.org) has been active on the Hill given, but the house leadership is not moving. All of this at the time when Countries like Canada are changing their Tax policy in favor of small business and venture (http://www.mondaq.com/canada/article.asp?articleid=99420). In addition to changes in capital taxation, in March 2010 , the Canadian government made a public commitment to implement the lowest statutory corporate income tax rate in the Group of Seven (G7) nations by 2012 (see nvca.org)

  2. admin
    June 14, 2010 at 3:37 pm

    Hi Tom,

    I believe in tax subsidies for developing areas of the economy where we need it, and this might include many types of ventures. But I don’t think we should blindly continue to provide subsidies to areas of the economy where we have reached saturation point or where the activities being subsidized are damaging. Either way, a better argument needs to be made for one group to pay at less than half the rate of another than to say “jobs will be lost” if the subsidy is withdrawn. On that reasoning the illegal drug trade should immediately be legalized.

    Having said this, we are both debating on the common assumption that well placed government subsidies are legitimate. Yet many of the players who want these subsidies or special treatment also vehemently rail against the regulation that must inevitably accompany it. They can’t have it both ways.

    Lawrence

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