One of the biggest gains from the Tax Cuts and Jobs Act was the increased incentives the bill created for decisions that spur economic growth.
Most notably, the bill moved toward a system of immediate expensing of capital investments, which will encourage companies to increase their investment in the economy. In turn, this will result in the long-term creation of new or better jobs and higher wages.
Ahead of the 2018 midterms, Democrats are running on a platform that would wipe out these gains. Senate Democrats have already proposed a $1 trillion tax hike (1,000,000,000) including several that would harm economic growth such as an increase in the death tax, higher taxes on businesses, and higher taxes on capital gains.
Unfortunately, Democrats are not the only ones pushing higher taxes in this space. Regrettably, Congressman Glenn Grothman (R-Wis.) is joining with Democrats in pushing for higher taxes on carried interest capital gains. This is disappointing because Rep. Grothman is otherwise a strong supporter of pro-growth tax reform and middle-class tax reduction.
A tax increase on carried interest capital gains is bad policy and would harm the economy. It is widely accepted that taxes on capital gains suppress growth and the creation of wealth.
Capital gains taxes are an additional layer of taxation in the code. Capital gains income has already been taxed at the individual level prior to reinvestment in the economy. This double taxation discourages savings, suppresses productivity, and discourages investment. It acts as a barrier to job creation, wage growth, and economic growth.
Simply, higher taxes on capital gains are higher taxes on investment, which negatively impacts 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 available from these partnerships dries up.
In addition to harming the economy, an increase in carried interest capital gains is bad policy. There is no difference between carried interest and any other type of capital gain, so differential tax treatment makes no sense.
Carried interest is simply 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.
The tax code rightly treats any income earned in this case as partnership income, meaning taxation flows through to individual taxpayers. The tax code also rightly treats this income as capital gains income as it is earned through long-term investment, not as ordinary income.
Undermining either of these two principles undermines the existing tax code as a whole by opening the door to arbitrarily higher taxes.
The tax treatment of carried interest capital gains was settled during the tax reform debate last year. 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 Cuts and Jobs Act.