Finance Committee Ranking Member Ron Wyden (D-Ore.) has introduced legislation that would increase taxes on carried interest capital gains by taxing it as annual compensation and at ordinary income tax rates.
This is problematic in two ways. First, it undermines the tax treatment of capital gains by discriminatorily taxing carried interest as ordinary income.
Second, it imposes taxes on carried interest income each year, rather than when income is realized from the sale of an investment.
The fact is, carried is structured based on longstanding norms of the tax code. The Wyden bill is terrible tax policy that should be rejected by Congress.
Taxing Unrealized Gains is Bad Tax Policy
Currently, the capital gains tax is imposed only when a taxpayer sells an asset. This makes sense because an investor does not receive any returns on the investment until they cash out.
The Wyden bill would undo this commonsense approach and force taxpayers to pay tax on unrealized gains every year.
This represents a dramatic departure from the norms of the tax code and could create needless complexity, arbitrary tax treatment, and perverse incentives.
Wyden has already introduced legislation that would require taxpayers to pay annual capital gains tax on all investments, so it is clear that Democrats are taking aim at increasing taxes on all capital gains, not just carried interest.
Carried interest capital gains drives significant investment across the country and in every Congressional District, so increasing taxes would harm economic growth.
More broadly, increasing taxes on capital gains – including taxes on carried interest capital gains – suppresses growth and economic productivity, harms the creation of jobs and wages, and reduces other government revenue sources.
Carried Interest Should Be Preserved As A Capital Gain
Taxing carried interest as ordinary income is bad policy that violates two long-standing tax principles.
Carried interest is rightly 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 it 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.