Taxes Aren’t Just for the Little People, After All

by Reggie Oldak, Senior Counsel,
and Joan Entmacher, Vice President for Family Economic Security,
National Women's Law Center

Congress is taking aim at a major tax loophole that allows extremely wealthy investment fund managers (the top 25 hedge fund managers earned an average of over $1 billion each last year) to pay lower tax rates than teachers, nurses, and other hard-working Americans. 

The provision to increase taxes on "carried interests" is included in the American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213), introduced jointly by acting House Ways and Means Committee Chair Sander M. Levin, D-Mich., and Senate Finance Committee Chair Max Baucus, D-Mont. yesterday. Both the House and the Senate are expected to vote on the bill next week, before they recess for Memorial Day.

Managers of investment partnerships—private equity funds, venture capital funds, real estate partnerships, and oil and gas partnerships, for example—often receive compensation for their work in the form of an interest in partnership profits that they don’t have to pay for. The interest is “carried” by the other investors. The new proposal would go far to close the loophole that allows investment managers to claim these earnings as capital gains—at the lower 15 percent rate, compared to the 35 percent marginal rate paid on earnings by the "regular" wealthy—even if they contributed none of their own money to the fund. Under the proposal released yesterday, income from carried interests would be taxed as 75 percent ordinary income and 25 percent capital gains.

The Joint Committee on Taxation has estimated that the proposal would raise $18.7 billion over 10 years to help pay for dozens of expired tax incentives that are collectively known as "extenders" because they are usually extended annually.

Lobbyists for the venture capital industry and others want the preferential treatment for their wealthy clients to continue. We applaud Rep. Levin and Sen. Baucus for standing up to them. Managers of venture capital funds (a category which includes such firms as Goldman Sachs) argued that they should continue to pay tax at a lower rate on their compensation because their work—providing investment advice to those who still have money to invest—creates jobs. But entrepreneurs who directly create jobs pay taxes at regular rates on their profits. Effective managers who help their companies expand pay taxes at regular rates on their salaries and bonuses. Teachers who develop the human capital our economy needs to grow pay taxes at regular rates. Workers who provide the goods and services we need and want pay taxes on their earnings at ordinary rates, too.

For years, the wealthiest Americans and corporations have been getting a free ride in the form of excessive tax cuts, tax breaks, and tax loopholes. Three times, the House has passed bills closing the "carried interest" loophole, but the proposal has never made it through the Senate. This Bill—which also provides crucial assistance to help struggling families, create jobs, and protect vital services—begins to hold the super-rich responsible for paying their fair share of taxes.