If You Get Paid for Services Performed, It’s Income. Isn’t It?

After 10 years and multiple trips through Congress, a bill recognizing “carried interest” as income and taxing it as income still hasn’t passed. How can that be? Carried interest is part of the compensation private equity firm and hedge fund managers earn for their work. It is a percentage of the profits or return on the assets they manage. Though they don’t need to invest their own money, this portion of their earnings is taxed as capital gains, rather than ordinary income. The difference is a 23.8% tax rate rather than the up to 39.6% they would pay if these earnings were called what they are—income, compensation for service performed.

Why does it matter? For several reasons. First, because it’s unfair. These managers commonly make upwards of $1 million per year, many in the tens of millions and some even hundreds of millions. Standard earnings include base pay of 2% of assets managed and 20% of profits or gross return. The latter is “carried interest.” For example, if a firm managed a $1 billion portfolio, 2% would generate $20 million in base pay. Profits and returns, the “carried interest,” may generate even higher amounts. But, for this example, let’s say $20 million. The first $20 million would be taxed as income, generating $7.92 million in tax revenue. But the $20 million of carried interest, taxed at the capital gains rate, would generate about 40% less tax revenue. Most Americans don’t get a lower tax rate on half of their income.

Most Americans don’t get a lower tax rate on half of their income.

Second, rather than helping to grow the economy, the lower tax rate incentivizes finding ways to further shelter earnings from taxes and investing in ways that don’t create jobs. Further, the unfairness incentivizes others to find ways to classify their own income as capital gains.

Third, the Joint Committee on Taxation estimated closing the carried interest loophole would raise $15.6 billion in revenue across a decade. This money could be used to lower the cost of higher education or healthcare, bolster our crumbling infrastructure or any number of programs that benefit society as a whole. Instead, the government foregoes this revenue to benefit a relatively small special interest group. This wealth concentration is one of the causes of widening income inequality.

U.S. Senator Tammy Baldwin (D-WI) and Representative Sander Levin (D-MI) are trying again to eliminate this tax loophole. On May 2, the legislators reintroduced the Carried Interest Fairness Act, supported by the Chair of the Patriotic Millionaires, Morris Pearl (video). It would be easy to think the bill will become law this time. President Trump even vowed to eliminate this loophole during his campaign. He said it’s been good for people like him but unfair to American workers. However, carried interest elimination didn’t make it into his initial tax reform proposal. Even if it eventually does, the loss of that tax break might be replaced with an even larger one. If the tax rate on pass-through businesses is lowered, as proposed, that tax break would then apply instead. Therefore, the Baldwin-Levin bill requires that the pass-through business rate remain the same.

“President Trump spent his entire campaign criticizing Wall Street and the carried interest loophole, claiming to be a man of the people who would drain the swamp and stand up to the oligarchs using their wealth to control our country. But now that he’s President, he’s seemingly forgotten about his promise to close the carried interest loophole. Instead, he’s filled his team in the White House with Wall Street tycoons and proposed a trickle-down tax plan that would give them (and himself) a massive tax cut.”  The Patriotic Millionaires

Whether you call it income, or whatever, why should these earnings be taxed less?  And please, don’t tell me this is risk-taking! Risk taking is what people do who strap themselves into harnesses and walk across open beams to lay the infrastructure for skyscrapers, or breathe the dust in coal mines. If their body gives out, so does their livelihood. Who takes care of them then? Police, firefighters—they take risks every day. What kind of tax rate is risking your life worth? Low-income students take out college loans, hoping to get a good-paying job that will keep them from being saddled with a lifetime of debt. But they’re vulnerable to changes in the economy and job market. That’s risk. Taking your life savings to open a restaurant or other small, sole-proprietorship business—that’s risk. Earning a commission on someone else’s investment, isn’t.

If we want to simplify the tax code, let’s do this. Stop torturing the definitions of words, siccing lobbyists on lawmakers, and paying attorneys to scour laws to see what they might twist.

As taxpayers, we demand fairness in the tax laws. So we should expect that only the first 2% of our salaries be taxed at the regular income rate, and the rest at the lower capital gains rate. Of course, we would need high dollar consultants, attorneys and planners to help us get the law changed in our favor.

The Patriotic Millionaires are offering to work with President Trump to get bipartisan agreement to pass the Carried Interest Fairness Act. But, they also warned him. If he doesn’t keep his campaign promise to stop this giveaway, they will spend the next four years ensuring that voters know he helps Wall Street at Main Street’s expense. We, on Main Street, also need to take action now. Let your Congress members know, special treatment for high-end earners won’t fly anymore.

In a system where big money always gets its way, most of us, in effect, are taxed without representation. History shows how Americans respond to such grave injustice.

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