Paul Krugman’s column today reminded me of a subject I haven’t written nearly enough about: tax rates on hedge-fund managers’ income. (I know it sounds dull, but it’s really not.) It’s a major topic of discussion in Congress right now, which is kind of a shame because the answer should be obvious. As Krugman noted, “The hedge fund tax loophole is a crystal-clear example of unjustified privilege.”
It all comes down to a bizarre quirk that allows hedge-fund managers to pay lower taxes than the rest of us.
For example, the 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.
Now, the debate is not about taxing capital gains like regular income, though some of the less honest among us might make that claim. The point here is that hedge-fund managers should see their income treated just like our income. The president, congressional Republicans, and a disconcerting number of Dems (Chuck Schumer, we’re looking at you) believe they deserve to keep a tax break that has no rational purpose.
And what a break it is. As a result of this inexplicable policy, the government loses out on $6.3 billion of revenue each year (a sum which would, Krugman notes, pay for healthcare for 3 million children). What’s more, almost $2 billion a year in unjustified tax breaks goes to just 25 individuals.
It’s time to change this bizarre tax break. As it turns out, those who understand the system best are those who are most active in demanding change.
Even the wealthy — at least those with social consciences — seem to share the new concern about restoring fairness to the tax system. The most prominent critic is mega-billionaire Warren Buffett, chief executive of Berkshire Hathaway and a director of The Washington Post Co. He famously admonished his fellow moguls a month ago that they were paying a lower tax rate than the people who cleaned their offices — and offered them $1 million if they could prove otherwise.
Buffett is hardly alone in his discomfort with a system that has led to an ever-wider disparity in the distribution of income. That’s what gives this movement traction: Some of the people who know Wall Street best understand how unfair the tax system is. A good example is Robert Rubin, a former Treasury secretary and, more to the point, a former head of Goldman Sachs. He recently joined those arguing that carried interest amounts to a fee paid to money managers and should thus be taxed as ordinary income.
A billionaire who runs one of the leading hedge funds wrote me in an e-mail last week: “Amusing what is going on in the tax charades of the money managers. How in the world anyone can uphold those [making] egregious amounts of money paying low or no taxes is really becoming laughable. . . . The private equity guys I know admit they do not have an argument that holds water.” This financier described watching a production of “Animal Farm” and realizing that “the vastness of the inequity that is escalating geometrically is just, well, Orwellian.”
I don’t expect much from the White House in the way of decency, but this should be a gut-check for congressional Dems. All of the leading Democratic presidential candidates are on board with ending the hedge-fund tax break — called “carried interest,” or “the carry” — as are a handful of noteworthy GOP elder statesman.
Rep. Sandy Levin (D-Mich.) is championing the bill to raise taxes on carried interest from the capital gains rate of 15% to ordinary income rates of as high as 35%. Its passage should be a no-brainer.
Irwin M. Stelzer, the director of economic policy studies at the right-leaning Hudson Institute, said flatly: “I don’t think there’s an argument on the equality side for the current tax treatment.”