Otto Von Bismarck, the Prussian statesman and architect of German unification, was reputed to have said, “Laws are like sausage, it is better not to see them being made.”
This cliché is relevant today as Congress plays politics with tax legislation. The House has passed a $1.4 trillion tax cut package, while the Senate will consider its version after Thanksgiving.
Comparing sausage making to how lawmakers do their work may be insulting to sausage makers, whose process is transparent and predictable. In contrast, when the intricacies of the tax legislation get too sensitive, politicians demure by claiming “it’s all part of the sausage making.” The implication is that the public would be better off not knowing the details of the legislative process.
As tax reform negotiations enter the final stage, the so-called carried interest loophole that provides preferential tax treatment for hedge funds and private equity firms remains largely untouched. When legislators are asked about closing this loophole they change the subject and recount the other loopholes they are ending.
Carried interest represents the share of profits that hedge funds, private equity, and other investment managers collect from clients. At issue is how much investors should be taxed on these profits. The managers typically take a 2 percent fee from investors and claim a share – generally 20 percent – of whatever profits they generate.
The 20 percent in profits these managers pocket, known as carried interest, is currently treated as a long-term capital gain and taxed at 23.8 percent: the capital gains rate of 20 percent plus the Obama health care surcharge of 3.8 percent on their income. That is well below the 39.6 percent rate plus the 3.8 percent surcharge they would pay if the money were treated as ordinary income.
As a candidate, President Trump repeatedly promised to close this loophole. He said, “The hedge fund guys didn’t build this country. These are guys that shift paper around and they get lucky.”
The carried interest provision is worth billions to super-rich Wall Street folks. Congress’s Joint Committee on Taxation has estimated that changing the treatment of carried interest could raise about $16 billion over the next decade. Academics claim the figure is more like $180 billion. Regardless of who is right, this is not chopped liver, so these wealthy financiers have pushed back with an army of lobbyists and sprinkled enough dollars around Washington to preserve their beloved tax break.
They argue that the lower long-term capital gains rate affords them an incentive to take investment risks that benefit the economy. This defies logic, since many of these managers are managing a pool of assets, not putting their own funds at risk.
Regardless of the merits, their efforts have yielded a handsome return. The House bill extends the period over which firms must hold an asset before it is eligible for the long-term capital gains rate from one year to three years. While that might bite some hedge fund managers, it will not touch the vast majority of private equity, venture capital, real estate investment managers.
They would still pay 23.8 percent on their income, roughly the same as someone making between $37,450.00 and $90,750.00 annually. The financiers pay taxes at a rate that is well below those that apply to much of the middle class, once again validating the influence Wall Street and wealthy investors exert in the Congressional sandbox. The strong take what they want and the weak suffer.
Meanwhile, the struggling middle and working-classes could really use the help. After adjusting for inflation, household incomes have not risen since the 1970s.
Instead the discrepancy between rich and poor has widened. Forty years ago, the richest Americans had more than 8 percent of the nation income, today it is about 20 percent. Which is why it’s so important for citizens to pay attention to the details of the legislative process.
Originally Published: Nov 25, 2017