Ugly as it is, pay attention to tax bill

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


Capping retirement accounts is a worrisome tax-cut notion

Tax cuts often look like free lunches for taxpayers. Such is the case with the recent federal tax reform proposal. But tax cuts eventually have to be paid for with tax increases, closing of tax loopholes, or spending cuts, and that’s why average Americans need to pay attention to the unfolding debate on Capitol Hill.

The first red flag came several weeks ago when it was reported that House Republicans were thinking of drastically slashing the tax deduction for 401(k) contributions from the current annual $18,000 or $24,000 for workers over 50 to as little as $2,400, and mandating the use of after-tax Roth accounts for retirement savings.

Retirement income in the United States comes primarily from three sources: Social Security, pension plans sponsored by public and private employers and individual savings in taxable and tax-advantaged accounts. There are generally two types of employer-sponsored pension plans: defined benefits and defined contributions.

Back in the day, workers could depend on defined benefit pensions in which retirees received a predetermined monthly annuity, either for the rest of their lives or those of their spouses. The benefit amount was usually based on an employee’s wage, years of service and age at retirement. The employer was responsible for contributing assets sufficient to fund the promised benefits.

But employers claimed these plans left them overburdened by pension obligations and that defined contribution plans were much less expensive.

Now defined-contribution pensions are the most common employer-sponsored plans.

Around 54 million American workers participate in about 550,000 so-called 401(k) plans, named after the section of the tax code that created them in 1978. These plans hold more than $5 trillion in assets. Tax-deductible contributions to defined contribution plans are predetermined, but the amount of benefits received upon retirement is not guaranteed.

Workers pay taxes when they withdraw the funds, manage the money themselves and hope the market doesn’t crash just when they retire. While in a defined benefit plan the employer bore the risks associated with investing assets in the plans, the employee is responsible for bearing those risks un-der defined contribution.

When news filtered out that the deduction for 401(k) contributions might be slashed, retirement experts, Vanguard, Fidelity and other large mutual fund companies that manage assets in the lucrative 401(k) business joined together and howled like a pterodactyl. President Trump tweeted, “There will be NO change to your 401(k). This has always been a great and popular middle-class tax break that works, and it stays!”

Fortunately, the long-awaited GOP tax plan unveiled last week leaves current contribution limits in place and abandons the notion that American workers are saving too much for retirement.

What were these Mighty Mendicants thinking? Cooking up a raiding party on workers’ 401(k) plans was a way to pay for the middle-class tax cuts lawmakers claim they want to provide. They also want to significantly cut corporate taxes to catch up with the rest of the world, which has already done so.

The proposal was pure budget chicanery. Capping what the average American can place in these pension plans would force workers to pay more in taxes now rather than when they make withdrawals from their pension account. In effect, the proposal would have helped pay for tax cuts by pulling future tax revenues forward.

Equally important, it would have undermined workers’ retirement security since the up-front deduction is an important incentive for workers to participate in retirement plans. Mil-lions of Americans depend on the favorable tax treatment of 401(k)s, IRAs and other savings vehicles to build long-term financial security.

The fate of House Republicans’ tax proposal is uncertain; the twists and turns ahead will surely provide first-rate entertainment. And taxpayers had best pay close attention to the tax legislation as it makes its way through Congress to ensure that the notion of capping 401(k) contributions is not resurrected as lawmakers scramble to find ways to pay for the tax cuts.