The carry

THE CARRY…. There’s no reasonable explanation to justify the hedge fund tax loophole. It’s a straightforward problem: the tax rates on hedge-fund managers’ income are, inexplicably, lower than the rates on everyone else’s income.

The debate is not about taxing capital gains like regular income. Rather, it’s a system that allows hedge-fund managers to pay capital-gains rates (15%) on their income, while everyone else pays income-tax rates.

The Obama administration apparently intends to address the “carried interest” loophole in his budget proposal.

The president will propose to tax the investment income of hedge fund and private equity partners at ordinary income tax rates, which are now as high as 35 percent and could return to 39.6 percent under his plans, instead of at the capital gains rate, which is 15 percent at most.

Senior Democrats in Congress joined with Republicans in 2007 to oppose that increase. But with Wall Street discredited and lucrative executive compensation a political target, the provision could prove more popular among lawmakers.

As Noam Scheiber noted, “I wasn’t sure Obama had it in him to close the loophole and am delighted to see that he might. (We’ll obviously have to wait and see if he fights for the measure, and if Congress signs on. But it’s a good start.)”

It is, indeed. Both parties have known about this costly loophole (more than $6 billion a year) for years, and both parties have been reluctant to address it (Chuck Schumer, I’m looking in your direction).

Paul Krugman, who called this “a crystal-clear example of unjustified privilege,” explained a while back why this should be a no-brainer.

[T]he salaries that pension fund employees receive for managing other peoples’ money are taxed as ordinary income, at rates up to 35 percent. But if that money is invested with a hedge fund — and 40 percent of the money in hedge funds comes from public, corporate and union pension plans — the fees the hedge fund manager receives for his services are mainly taxed as capital gains, with a maximum rate of 15 percent.

The arguments usually made on behalf of this unique privilege make no sense. We’re told that the tax rate on hedge fund managers has to be kept low to encourage risk-taking. But the managers aren’t risking their own money. The only risk they face is the uncertainty of their fees — and as any waitress who depends on tips or salesman who depends on commissions can tell you, most people with uncertain incomes don’t get any special tax breaks.

We’re also told that management fees would rise, reducing returns to investors, if the privileged status of fund managers is eliminated — as if someone with a $100-million-a-year hedge fund job would walk away if his take-home pay fell from $85 million to $65 million.

I’m glad the White House has the good sense to take this seriously. Here’s hoping Congress does the same.

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