The Senate this week and next is taking up the tax extenders package. Like its House counterpart, this bill is a clear violation of the Taxpayer Protection Pledge.  ATR will be keyvoting against this bill in our annual Congressional scorecard.

One provision that's getting a lot of notice is the tax hike on pensions, charities, and colleges (the "carried interest" tax hike). 

This version of the Senate bill raises the tax rate on these capital gains even higher than the original version did.  Under the Senate bill, a portion of capital gains from some investment partnership profits will be taxed as ordinary income.  What portion depends on the year, and whether the asset in question was held for at least five years.  Here's the percentage of capital gain which will be wrongly treated as ordinary income:

Time Asset Was Held Percent Taxed As Ordinary Income
<5 Years 75%
>5 Years 50%

In order to determine the effective tax rate based on this ratio, it's important to remember that the capital gains tax starting next year will be 20%, the top ordinary tax rate will be 39.6%, and the Obamacare investment surtax of 3.8% will take effect in 2013.  Once those numbers are crunched, here is the effective tax rate the bill imposes:

  2011-2012 2013-
Asset Held <5 Years 34.7% 38.5%
Asset Held >5 Years 29.8% 33.6%

Keep in mind that the 2010 rate on these capital gains is 15 percent, and the current-law capital gains tax rate for the above tax years is 20 percent.

That means that the tax rate on this income will double starting next year, and more than double starting in 2013.

This naked hike in capital gains taxes is only another step in the direction of taxing all capital gains as ordinary income, which is the real goal here.

PDF Version