US Tax - Carry will not be hiked

[Xisiqomelir]

Rolling Stone

Posted: Today,9:54 A.M. EDT | By Matt Taibbi
Obscene Tax Break Survives Again

Once again a key piece of news has passed virtually without comment.

While the entire nation argues over nonsense like the WTC Mosque, Rick Sanchez, and, yes, blue-red culture war stuff like the Tea Party, congress yesterday quietly took a knee on the “carried interest” tax question. In doing so they decided not to take a vote on changes already approved by both houses that would scale back perhaps the most preposterous tax break in the entire federal code, one that leaves hedge-fund gazillionaires like Stevie Cohen and John Paulson paying less than half the top tax rate paid by most middle and upper-middle class Americans.

The carried interest tax break is a classic example of how in America constituencies with the means and the bureaucratic endurance to get what they want slowly hack away at the government over time, carving out exemptions to their civic responsibilities while ordinary people suck the proverbial egg. A 100% or 200% tax break for hedge fund and private equity billionaires is not the sort of thing that one passes instantly, by standing up in front of big campaign crowds and urging on a mob; it takes a long time and a lot of behind-the-scenes baby steps.

Once upon a time, we didn’t make very many distinctions about taxable income. Whether you made your money driving trucks or buying and selling stocks, you made what you made and you paid the rate outlined in your bracket. Then a movement coalesced behind the idea that the government should give a tax break to those persons who made their money investing, because after all investment creates jobs (readers will note here my desperate attempt to avoid mentioning yet again the influence of Ayn Rand on these modern economic policies). At various times in our history, this resulted in, among other things, a tax break for income earned on capital gains, i.e. the money you make when you buy something (i.e. stocks) and then sell it later for a profit.

The capital-gains-cut movement was opposed by of all people Ronald Reagan, who in 1986 signed into law a thing called the Tax Reform Act that that ended capital gains exemptions and left all types of income taxed at the same rates. Some conservatives have never forgiven Reagan for this move. In any case, over the next 20 years, the capital gains cuts were gradually restored. Clinton in 1997 passed the Taxpayer Relief Act that cut the top rate from 28% to 20%. Then Bush came into office and with his famous monster cuts slashed the capital gains rate even further, to 15%. Bush also reduced taxes on dividends to the same rate as capital gains, 15%.

Now this was already madness: since most very wealthy people have much or all of their money tied up in investments and can easily structure their holdings so that their “income” comes in dividends and redeemed stock options and the like, that meant that thanks to Bush, in many cases your average secretary or Wal-Mart floor manager now paid a much higher tax rate than, say, Warren Buffett.

But as nuts as these tax breaks were, it’s important to point out that they at least had a thin reed of ideological justification to hang upon. It was mean, stupid and wrong ideology, but there was at least an idea there: the government providing a tax reward to people who invested their own money. One could claim – not quite plausibly, but at least with a level of justification that, say, a judge might consider valid enough to allow a jury to listen to – that this was not simply a handout to the rich, but an attempt to create jobs.

But then they went a step further and created the “carried interest” tax break. In this insane scenario, the income earned by managers of things like hedge funds, venture capital funds, gas partnerships and real estate partnerships would henceforth be taxed not as income but as “carried interest,” and “carried interest” legally would be taxed at the same rate as capital gains. The professional gamblers who manage things like hedge funds, people like John Paulson (you’ll remember him as the guy who worked with Goldman Sachs to cook up a toxic package of mortgages to dump on unsuspecting Dutch and German banks), typically get paid via something called the “two-and-twenty” arrangement. They get a two percent management fee (i.e., two percent of the big chunk of Other Peoples’ Money in their funds) plus 20% of whatever profits they make.

Hedge fund managers are not investing their own money. They are not, usually, using their own capital to create jobs. Mostly what they do is nibble the proverbial golden crumbs off of other peoples’ pies. Their particular role in society is to make rich people richer, a noble aim to be sure, but not one that in any way even theoretically incentivizes wealthy people to invest in businesses more or create more jobs.

There is absolutely no logical or ideological justification – not even the wildest, craziest reed-end of a hint of a justification – for a hedge fund manager paying half the tax rate of a trucker or a teacher or a doctor. The only thing the carried interest tax break accomplished was that it provided an incentive for people to work as hedge fund managers. This was purely and absolutely a handout to big campaign contributors. It’s so preposterous and indefensible that it’s not uncommon to see even Wall Street people admitting that it goes too far (see here for example).

Naturally this became a campaign issue in 2008. McCain, of course, supported keeping the carried interest exemption. Obama promised to end it. And indeed, toward the tail of his second legislative season, the Democrats took up the issue on the Hill.

What followed was an absolutely typical death of an obvious reform. The House took up the issue first, and even in the House version, the “reform” was to tax 75% of carried interest as ordinary income. Again, there’s no reason not to make this 100%, but this is the Democratic Party’s idea of tough bargaining/starting out with a high hand. The measure passed, then went to the Senate, where Max Baucus got hold of it and softened the bill so that now only 65% of carried interest would be taxed as income. To translate, again, this now would mean that only 65% of John Paulson’s billions would be taxed as income, while the rest would be taxed at 15%. It’s important to note that this change would not affect hedge fund or private equity guys who invested their own money; no matter what, that would still be considered capital gains and would be taxed at 15%.

The measure passed in the Senate, and for the rest of the summer lobbying groups hounded both chambers for carve-outs. Venture capitalists and real estate partnership managers came knocking for exemptions. The lobbying heat got turned up… and who can say for sure whether it worked or not, but we do know what happened in the end. Congress adjourned yesterday without voting on the final deal, meaning that it can’t be taken up again until after election day, when the congress will most likely be turned back over the Republicans. At which point there will be no way the carried interest exemption will ever get rolled back.

The Dems could of course vote it through during the lame-duck session, but they won’t.

"The tax on carried interest is by no means off the table," said Mark Heesen, president of the National Venture Capital Association, one of the groups that lobbied against the change. "But it's difficult to see it getting through in the lame-duck, particularly if Republicans take over the House."

A bummed-sounding John Kerry echoed Heesen’s gloating comment.

"If there are a lot of bridges burned and unhappy people [after the election], and people anticipate a major change-over in the Congress, it's going to be very hard to get things done,” Kerry said, referring among other things to the fund-manager tax break.

So there you have it. One of the very stupidest laws on our books, one a new president initially elected with a sweeping mandate promised to overturn, will not in the end be changed. It will appear that many people tried to change it, and there will be a lot of Democrats in particular who will be able to say that they voted to end the tax break for hedge fund assholes. But in the end, quietly, nothing got done. And let’s see how much the KKRs and Paulsons and Soroses of the world end up giving both parties in reward in 2010 (note that KKR is one of Max Baucus’s top 5 donors this year; Paulson is in his top 20). Anyone wanting a preview need only look at who hedge funds gave the bulk of their money to in ‘08.

(Hint: it wasn’t who you think).

Anyone who wants to play a fun game can go look up the 10K of one of the publically-traded megafunds (I recommend Blackstone) and see what a 33% hike in their tax expenses would yield to the government in revenue.