“Carried Interest” Battle Could Be Precursor to Broader Effort to Increase Capital Gains Tax

Writing for the Wall Street Journal, Phil Kerpen of Americans for Prosperity weighs in on the taxation of the returns to private equity funds. He notes, as have others, that the so-called “carried interest” is a capital gain – even if it is then shared with the fund manager. The key message of the article is that the attempt to raise the tax on this type of capital gains is the first step in an effort to raise the tax rate on all capital gains:

Under current law, individual partners in an investment partnership such as a hedge fund or private equity fund are taxed based on what the underlying partnership income is; if the income comes from a capital gain, it is taxed at the capital gains rate. Ordinary income is taxed at ordinary income tax rates. This tax treatment is consistent with the rationale for a lower capital gains tax rate – to alleviate the double taxation of corporate-source income and to encourage risk taking, entrepreneurship and capital formation. The legislation Congress is considering ends those protections, saying in effect that it doesn’t matter if the income is a clear-cut capital gain, such as proceeds from the sale of corporate stock. What matters is who receives the income, in this case politically unpopular rich guys. All investors should be on notice that if the capital gains tax is considered a loophole for investment partnerships, it can’t be long before the capital gains tax is raised for everyone else. Some leading Democrats, including Oregon Sen. Ron Wyden and presidential candidate John Edwards, are already calling to do just that.

Kerpen’s fears are confirmed by a story in the New York Sun. At a Finance Committee hearing, a number of politicians expressed support for broader tax hikes:

Democrats may dodge a tax hike on private equity managers and instead look to raise other taxes that would generate greater revenue from a broader swath of the American economy. At hearings on Capitol Hill yesterday, Senate Democrats voiced fresh doubts about legislative proposals to increase tax rates in the burgeoning private equity industry, questioning both the fairness of the plans and whether they would yield the revenue infusion lawmakers are seeking for the federal coffers. … Lawmakers indicated yesterday that they might turn their attention to more far-reaching tax shifts, such as increasing the rate on capital gains, to 20% from 15%, and the marginal income rate for the top-earning Americans, to 40% from 35%.