There’s a scene in an episode of "30 Rock" where corporate executive Jack Donaghey is teaching his stars Tracy and Angie Jordan about taxes. Jack explains that “estate planning is complicated, what with the government taking half” of all your savings after you die.
“What?” exclaims Angie, indignant. “That’s double taxation!”
“I like you, Angie,” Jack smiles, having won a conservative convert.
Discussing tax policy can be tricky and confusing, given the host of complicated terminology to master. To some, the desire for lower taxes on any financial vehicle sounds like the rich taking “more than their fair share,” but when it’s your money, any dime taken on an investment feels preposterously unfair — like double taxation.
Wages on labor are generally taxed at a higher rate than investments, based on the presumption that money saved and invested was already taxed when it was earned. This comes up every now and again with news reports of politicians or other VIPs who “pay less tax than their secretaries” — it makes a great headline and embarrasses a public figure, but contributes nothing to a discussion of tax policy.
Any capital gains — or money made from your money — that are held longer than a year are taxed at a lower rate than wages. Gains from investments held less than a year are taxed at the same rate as income, as a way for the government to discourage people from treating investing like gambling. (Or at least to profit from it.) Short-term capital gains are taxed more than long-term capital gains.
Given this approach, it’s odd when you hear politicians and pundits talk about targeting any kind of long-term investment. One that has come up recently is carried interest capital gains, or simply “carried interest,” that some want to tax at a higher rate.
This type of investment is an ownership stake in an operating business owned for years, and carries with it the same risk that the investment in the company might not generate a profit. In addition, carried interest is subject to a “claw back”: if subsequent profits aren’t achieved, carried interest income is returned.
Carried interest is not some kind of devious loophole or offshore tax scheme, and it’s unfair to view all investors as crooks. Millions of Americans are invested in these kinds of assets, either directly or indirectly, as retirement funds: private equity, venture capital, real estate and other partnerships are long-term investments whose profits are classified as carried interest.
As a financial vehicle, carried interest seems specifically designed for less-experienced investors. As people form a partnership, they hire a fund manager to handle the finances while they run the business. As the enterprise succeeds, it pays off long term to the partners, which is frequently how we fund endowments for universities, charities and even pension plans.
The fund managers are compensated through management fees (taxed as ordinary income) while their investment portion is taxed at capital gains rates. It’s their incentive to keep the finances afloat.
If, as was suggested in the campaign last year, the government raised the carried interest tax rate, it would damage any of the above-listed players, chasing away investment dollars or forcing the fund managers to offset the tax penalty with a larger cut for themselves.
This could hurt retirees and stifle job creation. According to the IRS, there are more than 3.2 million partnerships and more than 22 million partners, many of which could be negatively affected by this tax increase. One Desert News contributor last year suggested raising taxes on carried interest could scare investors away from Utah’s “Silicon Slopes.” Shortly thereafter, contributors to The Salt Lake Tribune detailed how it could hurt the 156,000 people invested in the Utah Retirement Fund.
Tax law has treated carried interest like capital gains for more than 100 years, meaning the practice has survived the Great Depression, inflation and every boom-and-bust of recent memory. Some suggest the tradition goes back as far as the 16th century, when ship captains would take a share of the profit on deliveries, compensating them for the effort and risk involved. That means it also survived pirate attacks. Now is not the time to undermine an investment standard that has spurred so much investment and innovation.
America already has the sixth-highest capital gains tax rate among the world’s most developed nations. As the administration and Congress ramp up discussions on tax reform, I hope they agree that reducing the tax burden on investments is a top priority and avoid any temptation to attack carried interest. Treating carried interested like income would be double taxation, like the death tax, and that’s the kind of plan we need to kill.
Jared Whitley is a veteran of Utah politics and journalism, having worked for the Senate, White House and myriad news outlets. Last year he won the Best in the West competition for column writing.