Congress must open its eyes to carried interest

When the 114th Congress convenes on Jan. 15 with a Republican majority in both houses,
comprehensive tax reform will be high on their to-do list. Among the first things they should address is ending the practice of treating so-called carried interest as ordinary income.

For those of you who did not grow up passing around copies of the tax code, there are few subjects more esoteric than America’s byzantine tax code. The federal tax code consists of nearly 74,000 pages and about four million words, twice the length of the King James Bible and the entire works of Shakespeare combined.

This voluminous magnum opus validates the average American’s suspicions that Washington is a stage of prancing marionettes tweaked by Wall Street (aka Crime Central) and other moneyed interests.

Rewriting the tax code is a difficult undertaking given the multitude of well-capitalized special interest groups from every comer of American business and society that have skin in the game when it comes to tax policy. Closing tax loopholes that favor particular groups instigates knock-down drag-out political fights. This is why the last serious tax reform came in 1986, also known as light years ago, under President Reagan.

One place to start comprehensive tax reform is to bring an end to the carried interest loophole, which allows super wealthy investment managers, including those in the private equity, hedge fund and venture capital business, to define their compensation as capital gains and pay income tax at a far lower rate. This forces ordinary people to pay more by transferring the burden to those who cannot afford tax attorneys.

Investment managers take a considerable portion of their pay as carried interest, which means being compensated for managing funds’ investments as a share of fund profits, without putting their own capital at risk. Under current tax law, carried interest is treated as a capital gain, subject to the top 20 percent capital gain rate plus a 3.8 percent surcharge on unearned income to help pay for the Affordable Care Act, rather than as ordinary income subject to the top marginal tax rate of 39.6 percent.

As former Treasury Secretary Robert E. Rubin noted several years ago, “I think what they’re doing is getting paid a fee for running other people’s money.” Put differently, carried interest is performance­ based compensation for investment management services rather than a return on financial capital invested by managers.

The one-percenters, who tend to be big political donors, are the principal beneficiaries of carried interest. Quite apart from basic fairness, treating all taxpayers who provide a service the same, the Obama administration has estimated that ending this tax loophole would generate an additional $15 billion in revenue over 10 years.

For a long time, this loophole has unfairly enabled some of the highest paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all. Legislation is needed to fix the carried interest dodge and ensure that income earned managing other people’s money is taxed at the same rates as that earned by teachers, factory workers, attorneys and millions of other Americans for the services they provide.

Because of the financial sector’s outsized influence, you can expect to hear how closing the carried interest loophole will destroy capitalism as we know it and undermine the economy. Experience teaches us that the financial sector’s lobbying clout, combined with the fact that doing the right thing is a dangerous luxury for politicians, Main Street standing on the sidelines is not a recipe for success on this issue.

The American public has to actively engage and abandon the assumption that so many things are now taken for granted that it’s as if the public literally no longer sees them.

originally published: December 27, 2014

Congress must open its eyes to carried interest

When the 114th Congress convenes on Jan. 15 with a Republican majority in both houses,
comprehensive tax reform will be high on their to-do list. Among the first things they should address is ending the practice of treating so-called carried interest as ordinary income.

For those of you who did not grow up passing around copies of the tax code, there are few subjects more esoteric than America’s byzantine tax code. The federal tax code consists of nearly 74,000 pages and about four million words, twice the length of the King James Bible and the entire works of Shakespeare combined.

This voluminous magnum opus validates the average American’s suspicions that Washington is a stage of prancing marionettes tweaked by Wall Street (aka Crime Central) and other moneyed interests.

Rewriting the tax code is a difficult undertaking given the multitude of well-capitalized special interest groups from every comer of American business and society that have skin in the game when it comes to tax policy. Closing tax loopholes that favor particular groups instigates knock-down drag-out political fights. This is why the last serious tax reform came in 1986, also known as light years ago, under President Reagan.

One place to start comprehensive tax reform is to bring an end to the carried interest loophole, which allows super wealthy investment managers, including those in the private equity, hedge fund and venture capital business, to define their compensation as capital gains and pay income tax at a far lower rate. This forces ordinary people to pay more by transferring the burden to those who cannot afford tax attorneys.

Investment managers take a considerable portion of their pay as carried interest, which means being compensated for managing funds’ investments as a share of fund profits, without putting their own capital at risk. Under current tax law, carried interest is treated as a capital gain, subject to the top 20 percent capital gain rate plus a 3.8 percent surcharge on unearned income to help pay for the Affordable Care Act, rather than as ordinary income subject to the top marginal tax rate of 39.6 percent.

As former Treasury Secretary Robert E. Rubin noted several years ago, “I think what they’re doing is getting paid a fee for running other people’s money.” Put differently, carried interest is performance­ based compensation for investment management services rather than a return on financial capital invested by managers.

The one-percenters, who tend to be big political donors, are the principal beneficiaries of carried interest. Quite apart from basic fairness, treating all taxpayers who provide a service the same, the Obama administration has estimated that ending this tax loophole would generate an additional $15 billion in revenue over 10 years.

For a long time, this loophole has unfairly enabled some of the highest paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all. Legislation is needed to fix the carried interest dodge and ensure that income earned managing other people’s money is taxed at the same rates as that earned by teachers, factory workers, attorneys and millions of other Americans for the services they provide.

Because of the financial sector’s outsized influence, you can expect to hear how closing the carried interest loophole will destroy capitalism as we know it and undermine the economy. Experience teaches us that the financial sector’s lobbying clout, combined with the fact that doing the right thing is a dangerous luxury for politicians, Main Street standing on the sidelines is not a recipe for success on this issue.

The American public has to actively engage and abandon the assumption that so many things are now taken for granted that it’s as if the public literally no longer sees them.

originally published: December 27, 2014

A day that should live in infamy

Early in 1941, the government of resource-poor Japan realized that it needed to seize control of the petroleum and other raw material sources in the Dutch East Indies, French Indochina and the Malay Peninsula. Doing that would require neutralizing the threat posed by the U.S. Navy’s Pacific Fleet based at Pearl Harbor in Hawaii.

The government assigned this task to the Imperial Navy, whose combined fleet was headed by Admiral Isoroku Yamamoto. The Imperial Navy had two strategic alternatives for neutralizing the U.S. Pacific Fleet. One was to cripple the fleet itself through a direct attack on its warships,  or cripple Pearl Harbor’s ability to function as the fleet’s forward base in the Pacific.

Crippling the U.S. fleet would require disabling the eight battleships that made up the fleet’s traditional battle line. It was quite a tall order.

The most effective way to cripple Pearl Harbor’s ability to function as a naval base would be to destroy its fuel storage and ship repair facilities. Without them, the Pacific Fleet would have to return to the U.S., where it could no longer deter Japanese military expansion in the region during the year or so it would take to rebuild Pearl Harbor.

It soon became apparent that the basics of either strategy could be carried out through a surprise air raid launched from the Imperial Navy’s six first-line aircraft carriers. Admiral Yamamoto had a reputation as an expert poker player, gained during his years of study at Harvard and as an Imperial Navy naval attache in Washington. He decided to attack the U.S. warships that were moored each weekend in Pearl Harbor. But in this case the expert poker player picked the wrong target.

The Imperial Navy’s model for everything it did was the British Royal Navy. Standard histories of the Royal Navy emphasized its victories in spectacular naval battles.

Lost in the shuffle was any serious consideration of trying to cripple Pearl Harbor’s  ability to function as a forward naval base. So it was that, in one of history’s finest displays of tactical management, six of the world’s best aircraft carriers furtively approached the Hawaiian Islands from the north just before dawn that fateful Sunday, Dec. 7, 1941, launched their planes into the rising sun, caught the U.S. Pacific Fleet with its pants down and wrought havoc in spectacular fashion. On paper at least, this rivaled the British Royal Navy’s triumph at Trafalgar.

But so what?

The American battleships at Pearl Harbor were slow-moving antiques from the World War I era. As we know, the U.S. Navy already had two brand new battleships in its Atlantic Fleet that could run rings around them. And eight new ones the navy was building were even better.

More importantly, the Pacific Fleet’s three aircraft carriers weren’t at Pearl Harbor. American shipyards were already building 10 modem carriers whose planes would later devastate Imperial Navy forces in the air/sea battles of the Philippine Sea and Leyte Gulf.

Most importantly, as the sun set on Dec. 7 and the U.S. Navy gathered the bodies of its 2,117 sailors and Marines killed that day, all-important fuel storage and ship repair facilities remained untouched by Japanese bombs, allowing Pearl Harbor to continue as a forward base for American naval power in the Pacific.

So in reality, Dec. 7 marked the sunset of Japan’s extravagant ambitions to dominate Asia. Admiral Yamamoto and the Imperial Navy’s other tradition-bound leaders chose the wrong targets at Pearl Harbor.

The dictates of tradition are usually the worst guides to follow when it comes doing anything really important. After all, if they survived long enough to be venerated, they’re probably obsolete.

Originally published: December 6, 2014

A day that should live in infamy

Early in 1941, the government of resource-poor Japan realized that it needed to seize control of the petroleum and other raw material sources in the Dutch East Indies, French Indochina and the Malay Peninsula. Doing that would require neutralizing the threat posed by the U.S. Navy’s Pacific Fleet based at Pearl Harbor in Hawaii.

The government assigned this task to the Imperial Navy, whose combined fleet was headed by Admiral Isoroku Yamamoto. The Imperial Navy had two strategic alternatives for neutralizing the U.S. Pacific Fleet. One was to cripple the fleet itself through a direct attack on its warships,  or cripple Pearl Harbor’s ability to function as the fleet’s forward base in the Pacific.

Crippling the U.S. fleet would require disabling the eight battleships that made up the fleet’s traditional battle line. It was quite a tall order.

The most effective way to cripple Pearl Harbor’s ability to function as a naval base would be to destroy its fuel storage and ship repair facilities. Without them, the Pacific Fleet would have to return to the U.S., where it could no longer deter Japanese military expansion in the region during the year or so it would take to rebuild Pearl Harbor.

It soon became apparent that the basics of either strategy could be carried out through a surprise air raid launched from the Imperial Navy’s six first-line aircraft carriers. Admiral Yamamoto had a reputation as an expert poker player, gained during his years of study at Harvard and as an Imperial Navy naval attache in Washington. He decided to attack the U.S. warships that were moored each weekend in Pearl Harbor. But in this case the expert poker player picked the wrong target.

The Imperial Navy’s model for everything it did was the British Royal Navy. Standard histories of the Royal Navy emphasized its victories in spectacular naval battles.

Lost in the shuffle was any serious consideration of trying to cripple Pearl Harbor’s  ability to function as a forward naval base. So it was that, in one of history’s finest displays of tactical management, six of the world’s best aircraft carriers furtively approached the Hawaiian Islands from the north just before dawn that fateful Sunday, Dec. 7, 1941, launched their planes into the rising sun, caught the U.S. Pacific Fleet with its pants down and wrought havoc in spectacular fashion. On paper at least, this rivaled the British Royal Navy’s triumph at Trafalgar.

But so what?

The American battleships at Pearl Harbor were slow-moving antiques from the World War I era. As we know, the U.S. Navy already had two brand new battleships in its Atlantic Fleet that could run rings around them. And eight new ones the navy was building were even better.

More importantly, the Pacific Fleet’s three aircraft carriers weren’t at Pearl Harbor. American shipyards were already building 10 modem carriers whose planes would later devastate Imperial Navy forces in the air/sea battles of the Philippine Sea and Leyte Gulf.

Most importantly, as the sun set on Dec. 7 and the U.S. Navy gathered the bodies of its 2,117 sailors and Marines killed that day, all-important fuel storage and ship repair facilities remained untouched by Japanese bombs, allowing Pearl Harbor to continue as a forward base for American naval power in the Pacific.

So in reality, Dec. 7 marked the sunset of Japan’s extravagant ambitions to dominate Asia. Admiral Yamamoto and the Imperial Navy’s other tradition-bound leaders chose the wrong targets at Pearl Harbor.

The dictates of tradition are usually the worst guides to follow when it comes doing anything really important. After all, if they survived long enough to be venerated, they’re probably obsolete.

originally published: December 6, 2014