LETTING WEALTHY investors game the tax code does not promote a dynamic economy. Yet Massachusetts Senators John Kerry and Scott Brown have both accepted the dubious premise that future growth will suffer if managers of investment partnerships, including hedge funds, private equity, and venture-capital firms, have to pay taxes at the same rates as everyone else.
While the top federal income tax rate is 35 percent, capital gains — the money generated from successful longer-term investments — are generally taxed at only 15 percent. Lead partners in investment funds typically receive a management fee, which is taxed as ordinary income, but also take a portion of any increase in the value of the money they invest for other people. This cut is just another form of payment for the professional services managers provide to investors, but it’s still taxed at the lower capital gains rate. The benefit to some of the nation’s wealthiest taxpayers is enormous; the tax break costs the US Treasury $25 billion a year.
The loophole is an obvious target as Congress looks for ways to pay for the extension of unemployment benefits amid a continuing downturn. But investment partnerships have used that dynamic to their advantage, implying that Congress is arbitrarily sticking them up for money to fund its own priorities — and doing so in a way that will discourage investment in high-tech startups.
Kerry and Brown have both proved receptive to this argument. While Kerry has backed a compromise that would eventually subject most of the money in question to income-tax rates, he also helped weaken an effort simply to abolish the loophole. Brown has generally opposed higher taxation and expressed particular concern that venture-capital firms would suffer if the loophole disappears.
Venture capitalists surely have a more appealing story to tell than hedge-fund and private-equity managers. The industry gets credit for its role in funding new startups, and it argues that managers are less likely to do the legwork of investigating promising companies and lining up outside investors if a higher tax rate diminishes their own personal return. But people in any field could make similar claims. Is the work of venture-capital managers so much more valuable to society than that of scientists, teachers, doctors, or anyone else who pays standard income tax rates on their earnings?
Current legislation to narrow the loophole would raise $13 billion, by one estimate. Brown should at least join Kerry in supporting that compromise, not just because it’s a reasonable way to pay for unemployment benefits, but because it’s also a wise change on its own terms. The tax code shouldn’t give favorable treatment for investment managers, and senators shouldn’t accept self-serving claims by recipients of an unjustified break.
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