Increasing Taxes on Carried Interest is A Terrible Idea


Posted by Alex Hendrie on Wednesday, March 13th, 2019, 10:44 AM PERMALINK

Democrats have vowed higher taxes on the American people across every income level and on businesses large and small.

Already, they have proposed repealing the entire GOP passed Tax Cuts and Jobs Act, raising the corporate rate to 28 percent, increasing the top income tax rate to 70 percent, and instituting a financial transactions tax on the sale of every stock, bond, or derivative.

The latest Democrat tax hike proposal comes from Senator Tammy Baldwin (D-Wis.) and Congressman Bill Pascrell (D-NJ) and would increase taxes on carried interest capital gains.

This is a terrible idea.

 “The left’s stated long-term goal is to tax all capital gains as ordinary income. Taxing carried interest is the opening salvo in this goal,” said Grover Norquist, President of Americans for Tax Reform. “On principle, carried interest should be taxed as capital gains not at artificially higher rates.”

There is no justification for increasing taxes on carried interest. The tax treatment of carried interest capital gains is based on long-standing principles of the tax code and is simply a trojan horse toward raising taxes on all capital gains.

Increasing taxes on carried interest is bad policy that fails to raise any significant amount of revenue and undermines pro-growth tax reform.

A Tax Increase on Carried Interest Capital Gains Would Harm Economic Growth

The goal of Democrats is to increase taxes on all capital gains. Many view a tax increase on carried interest is just the first step.

For instance, 2016 presidential candidate Hillary Clinton wanted dramatic tax increases on capital gains including a tax increase on carried interest.

Capital gains taxes are a tax on investment and negatively impact pension funds, retirement savings, charities, and colleges that depend on robust investment in order to meet savings goals. Small businesses would also be badly affected as investment money would dry up.

This same is true for carried interest – investment associated with carried interest capital gains drives significant economic growth across the country.

It is widely accepted that taxes on capital gains – including taxes on carried interest capital gains –  suppress growth and economic productivity, harm the creation of jobs and wages, and reduces other government revenue sources.

Carried interest is a Mainstay of the Tax Code

Carried interest is grounded in two long-standing tax principles.

It is treated as partnership income, meaning taxation flows through to individual taxpayers. In this case, carried interest is the investor’s share of partnership income they receive for providing expertise on investment decisions. All taxpayers involved in the partnership – those providing expertise and those providing capital – are taxed the same.

It is also treated as capital gains income as it is earned through long-term investment, not as ordinary income. There is no justification for treating this as ordinary income – the investor purchased an asset, grew the asset by making it more economically valuable, and sold the asset at a profit – exactly the same as other types of investment.

Undermining either of these two principles undermines the existing tax code as a whole by opening the door to arbitrarily higher taxes.

A Tax Increase on Carried Interest Capital Gains Fails to Raise Meaningful Revenue

Not only is a tax hike on carried interest bad policy, it would fail to raise any significant revenue and so is useless as a pay-for.

In fact, taxing carried interest as ordinary income would raise just $14 billion over ten years, according to the Congressional Budget Office.

For context, the estimated price tag of Medicare for all is $32 trillion, while the price tag of the Green New Deal is at least $91 trillion. Carried interest is a drop in the bucket compared to these proposals.

The Tax Treatment of Carried Interest Was Settled During Debate over the Tax Cuts and Jobs Act

Republicans should not be fooled into increasing taxes on carried interest as the issue has already been litigated.

The Tax Cuts and Jobs Act was developed under an extensive regular order process that involved six years of debate and more than 40 hearings in the House Ways and Means Committee.

After significant debate, lawmakers chose to maintain the tax treatment of carried interest as partnership income that is treated as a capital gain.

Choosing to increase taxes on carried interest capital gains by arbitrarily changing the tax treatment of this type of income would undermine the treatment of all capital gains and erode the gains of the tax reform.

 

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