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All Da King's Men

A Tax Loophole Worth Closing

By Da King Published: January 18, 2012

According to ABC News, Republican presidential hopeful Mitt Romney said he "probably" pays about 15% in federal incomes taxes:

Romney said he “probably” pays only about 15 percent in federal taxes because most of his earnings come from capital gains, which is taxed at a lower rate than traditional income. This means the super wealthy Romney pays a significantly lower tax rate than most middle income Americans.

I was a bit surprised by this, because I know Romney still receives income from Bain Capital, which I figured would be taxed at regular income rates, not the lower capital gains tax rates.

As it turns out, that is not true. Due to a tax loophole, Bain Capital and other private equity firms are taxed at the lower capital gains tax rates for income they receive for managing other people's money:

Managers of private equity firms like Romney are often paid under an arrangement in which they receive both a set fee for their management, as well as a share of the profits that the firm makes for investors. While their management fees are taxed at normal income tax rates, the share of investor gains that go to a private equity manager (called "carried interest") are treated as capital gains, and thus taxed at a top rate of 15 percent. (Hedge fund managers and partners in real estate ventures also benefit from receiving carried interest.)

Here's the problem with that. The argument for taxing capital gains at a lower rate than regular income is that it spurs investment, which leads to economic growth and job creation. I'm completely on board with that concept. The last thing I want to do is punish investment and risk taking, but what's happening with the "carried interrest" of private equity firms being taxed at the lower rate is different. Private equity managers like Romney was are receiving a tax break for income derived from investing other people's money, not their own, and that's a key difference. Because the equity manager is not putting his own money at risk, it seems the income the manager derives from his services should not be considered a capital gain at all, it should be considered regular income. The manager is receiving a fee for services rendered, regardless of how it is structured.

Here's how Peter Orszag put it:

Former Office of Management and Budget Director and current Citigroup Vice Chairman of Global Banking Peter Orszag said that the carried interest loophole is akin to a famous actor's portion of a movie's revenue being taxed as capital gains, a proposition that most people would hopefully find absurd. Citizens for Tax Justice opined that carried interest "is clearly compensation for services and not a return on investment," and that private equity managers "should pay income taxes at ordinary rates on their compensation, just like everyone else, from the folks who sweep their floors or answer their phones to CEO's exercising stock options and professional athletes getting playoff bonuses."

I can't argue with that. Sounds right to me.

Here's why it affects Romney's tax burden:

Thanks to a lucrative retirement package, Romney is still making millions from Bain, much of which is likely being taxed as carried interest. (While Romney has refused to make his tax returns public, he's said that all of his income is taxed at investment rates.) Analysts have estimated that Romney's tax rate is about 14 percent, lower than that of many middle class families.

Romney isn't doing anything wrong, but this tax loophole should go away.

So, why hasn't it gone away ???

The House Of Representatives passed a bill to remove this tax loophole in 2010, but the bill died in the Senate, as it has for three years in a row. I don't have the numbers (I'm not enjoying this Wikipedia blackout), but it seems to me more Democrats are on the right side of this issue than are Republicans, and needless to say, money managers are lobbying hard against it. With our astronomical deficit and debt numbers, this would be one good place to enhance revenue. You won't hear me condone tax increases very often, but in this case, it really does have to do with the rich paying their "fair share", because they aren't.



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