Lawmakers Should Oppose Efforts to Increase Taxes on Carried Interest Capital Gains

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Posted by Alexander Hendrie on Wednesday, May 10th, 2017, 1:00 PM PERMALINK

A long-term goal of Democrat politicians is increasing the capital gains tax.

Often, the Left claims that the capital gains tax is a loophole that should be closed. What they really mean is they want to increase the capital gains tax from its current rate of 23.8 percent to 43.4 percent, so it is taxed as ordinary income (The 39.6 percent individual rate plus the Obamacare 3.8 percent net investment income tax).

At other times, they aim to incrementally increase the tax on capital gains. One of their favorite targets is carried interest capital gains. Just last week, Senator Tammy Baldwin (D-WI) introduced legislation that would increase taxes on carried interest.

This is bad policy. Increasing taxes on carried interest capital gains would reduce investment and savings, and hurt the economy. In addition, it would raise a miniscule amount of revenue and take the tax code in the wrong direction. Lawmakers should reject Senator Baldwin’s misguided proposal.

There is a widespread misconception that treating carried interest as a capital gain is a loophole. The truth is, carried interest is identical to all other capital gains and there is little justification for treating it as ordinary income. Carried interest is the share of an investment partnership allocated to the investor. These partnerships occur when individuals with capital and individuals with expertise pool their resources together.

Those who derive income from carried interest capital gains don’t have some special deal – they pay the same capital gains rates as everyone else. All income from a partnership is derived from a long-term investment in a business or real estate and so all income is treated as a capital gain.

Increasing taxes on carried interest capital gains would raise a miniscule amount of revenue. According to the Joint Committee on Taxation, taxing carried interest as ordinary income would raise just $19.6 billion over the next decade, a drop in the bucket compared to the projected $41.7 trillion that the Congressional Budget Office estimates will be raised over that time frame.

Increasing taxes on carried interest capital gains would have negative economic impacts. When accounting for effects on the economy, the Tax Foundation estimates revenue from taxing carried interest as ordinary income would fall to just $13 billion due to negative macroeconomic effects.

This negative impact would be felt by pension funds, charities, and colleges that depend on investment partnerships as part of their savings goals. In addition, small businesses would find themselves increasingly shut out from investment money available to them from these partnerships.

Better policy would be reducing taxes on capital gains. Ideally, none of the income derived from a capital gain should be taxed as it is one of several layers of taxation in the existing tax code. This tax is levied on income that has already been taxed at the individual level and is then reinvested into the economy. This extra layer of taxation creates a bias against savings and suppresses productivity and new investment. In turn, this hinders the creation of new jobs, higher wages, and increased economic growth.

Capital gains taxes are already high. Over the past eight years, the top rate increased from 15 percent to 23.8 percent. A study by Ernst and Young placed the top U.S. integrated rate at 56.3 percent after accounting for the corporate tax, federal and state capital gains taxes, and the Obamacare net investment income tax. In contrast, the average integrated rate amongst nations in the Organisation for Economic Co-operation and Development and the five member BRICS countries sits at just 40.3 percent.

Rather than push for a tax increase on capital gains, lawmakers should look to reduce the tax to promote economic growth and end the distortions in the tax code.

 

Photo Credit: https://www.flickr.com/photos/144152028@N08/

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