Close My Tax Loophole

http://www.nytimes.com/2016/08/27/opinion/close-my-tax-loophole.html

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My fellow venture capitalists and private equity investors are paying close attention to the heated election-year rhetoric about the future of “carried interest,” which is the performance fee we charge to manage other people’s money. Carried interest is the fund manager’s share of the earnings from a profitable investment, normally paid on top of a much smaller management fee.

It’s also a subject of increasing political disfavor. Over the past year, every major presidential candidate — from Jeb Bush and Donald J. Trump to Hillary Clinton and Bernie Sanders — has called for an end to a tax loophole that exists for carried interest. Mrs. Clinton has vowed that if Congress does not close the loophole, as president she would ask the Treasury Department to use its regulatory authority to do so.

Ultimately, the controversy has to do with tax fairness, or the lack thereof. Instead of being taxed as wages or commissions earned, carried interest is currently taxed as if it were a personal investment, or capital gains. This gives us a significant tax advantage since the capital gains tax rate is about 50 percent lower than the top rate on ordinary income.

When I started my first fund, Alan Patricof Associates, in 1970, I vividly remember my accountant telling me about my first sale of an investment: “We’re going to treat this as capital gain, but sooner or later, it will be characterized as ordinary income.”

That was 46 years ago — and virtually nothing has changed.

Other countries have taken action: Britain recently recognized the wisdom of doing away with the special tax treatment of carried interest by maintaining a much higher tax rate on such income. But not the United States.

It is past time for that to change, and for fund managers like myself to accept the reality: We should not be receiving a tax break meant for investors when our work does not involve the risk of our own investment of capital.

As the former Treasury secretary Larry Summers once said of carried interest, “Rarely has a policy existed so long with such weak arguments in its favor.”

The capital gains tax benefit was originally created for people who invested with their own capital at risk. It was established as an incentive for investors to take greater risk than they would with their ordinary income. But because of the nature of our work, carried interest does not merit that incentive.

To the extent that venture capitalists and private equity investors have their own capital invested in their own or any funds, they deserve capital gains treatment, just as any other limited partner does. But the same does not hold true for a general partner.

The general partner is managing the funds of others and rarely puts his own money into the initial investment. The risk he takes is that his ultimate payout is not guaranteed unless the venture is profitable — which is very different from the investor who is putting his own money at stake.

And there is a cost. According to the Congressional Joint Committee on Taxation, carried interest costs the American people nearly $2 billion in tax receipts every year. While eliminating the carried interest advantage would make only a small dent in the national debt, it would send a meaningful message to the American people.

Most important, it comes back to a question of fairness. Our current political and cultural environment is marred by a toxic belief that the country’s economic order is rigged against ordinary Americans — that the world of high finance unjustly supersedes their rights, needs and wants.

A new report by Gallup found that 86 percent of Americans agreed that members of Congress paid too much attention to what their major financial contributors wanted them to do. It feeds the cynicism that is fraying our democracy.

“Congress’s harshest critics,” Gallup reported, “feel more strongly about the undue influence that donors and lobbyists have on Congress than they do about any other major criticism of the institution.”

For that reason alone, my fellow venture capitalists and private equity investors should support the closing of the carried interest loophole: It would carry great symbolic weight.

There needs to be a more realistic attitude from those of us who have benefited from the carried interest loophole for too many years.

We need to demonstrate a little more patriotism, and a greater sense of fairness, even if it affects our pocketbooks.