CT Blue

There are few things more glaringly unfair in this country than the fact that hedge fund managers get taxed at a rate less than half of what most of the rest of us pay. According to this morning’s Globe, (Tax break on profits again in jeopardy) there’s a move afoot in Congress to change the law, but the takeaway upon closer reading is that nothing will change:

The endurance of the special tax break is testament not only to the power of financial industry lobbyists but also to the support of key lawmakers. For example, Representative Richard Neal of Massachusetts, a member of the House Ways and Means Committee, voted against the tax break in 2008 and acknowledges the provision is perceived by many to be unfair. But now he wants to delay action, saying he is worried that eliminating the tax break this year could be “a job killer at a very precarious time.’’

Neal said he wants the matter addressed next year in broader legislation for a tax overhaul. Referring to the perception of unfairness when private-equity firms benefit from the current tax policy while laying off employees in job restructuring, he said, “You can’t defend it.’’

You can’t defend it, but he doesn’t want to change it.

The theory is that the income hedge managers receive should be taxed as a capital gain because it is derived from capital gains; that is, they get a percentage of whatever they earn for their clients. They do not share in the losses of course. That would be asking too much.

It is a mystery to me how anyone can claim that taxing these people at the same rate as the rest of us will cost jobs. The folks making this claim are always sort of vague about whose jobs are at risk. Maybe it’s the gardeners or personal trainers these people employ. This from the Economic Policy Institute:

Defending this tax break are highly paid lobbyists such as Douglas Lowenstein and Grover Norquist who loudly and repeatedly make the claim that taxing hedge fund managers like everyone else will harm the average working family. They claim that taxing hedge funds like normal income will harm pension fund returns. This is wrong on two levels. First, the tax change would apply to hedge fund managers and not investors (many pension funds invest in hedge funds). Second, pension funds do not pay taxes. These lobbyists also claim that it would increase the cost of consumer goods and services because so many stores and chain restaurants are owned by private equity firms and hedge funds. This, too, is preposterous because, again, the tax does not apply to the investors or owners of those businesses but only the investment advisors who manage the funds of those investors. Moreover, the businesses owned by private pools of capital will have to compete with other similar businesses providing consumer goods and services—only now on a level playing field—and they will not be able to arbitrarily raise their prices.

As I understand it, we tax long term capital gains at a low rate in order to encourage long term investment. Since hedge fund managers depend on investment (by other people) it seems unlikely that taxing them at a higher rate would lower investment. Again, from the EPI:

There are two things economically wrong with this special tax provision for hedge fund managers. First is its impact on economic efficiency. It creates inconsistent economic incentives (i.e., distortions) for some labor income to be treated as ordinary income while other labor income is treated as capital gains, and the work done by investment advisors is undeniably a professional, laboring activity. Fund managers at pension funds, trusts, and endowments who provide similar professional services are paid a salary and possibly a bonus, and these are all treated as ordinary income. Only because hedge funds and private equity firms are organized as limited liability partnerships—which are already treated favorably for tax and liability purposes—are these same professional services taxed differently. The result is a distortion in the compensation and after-tax income between these super rich hedge fund managers and millions of others in the workforce.

The amounts of money involved are staggering:

A simple calculation shows that this preferential tax treatment for the top 25 individuals alone costs the Treasury almost $2 billion.

The fact that so much money is involved for so few people puts the lie to the idea that fairly taxing these people would discourage them from doing the same job they are doing now. They would still make piles of money were they taxed at a higher rate. Where else could they go to make so much money doing something so socially useless?

Yet, it would be reckless in the extreme to believe or even hope that the Democrats will do away with this tax giveaway. Representative Neal cannot defend it, but he prefers to wait until next year to deal with it, which is Beltway speak for saying he intends to do nothing about it at all.