Clipping Hedge Funds

I criticize President Obama quite a lot.  So when I get a chance to agree with him, I feel to be out of step with myself.  However, his calling for hedge fund managers to pay taxes on their compensation ... as though it were ordinary income ... strikes me as quite rational (see: Huffington Post Story).  The reason that these barons of Wall Street ... such as Warren Buffet ... currently get away with paying 20% (just upped from 15%) on their hedge-fund compensation (which often can runs into the tens, if not hundreds of million dollars) is that it is treated as "carried interest" ... in other words, it is viewed for tax purposes by the IRS as though it were real interest on invested capital.  It most often isn't.  The definition of "carried interest" is:

"A share of any profits that the general partners of private equity and hedge funds receive as compensation, despite not contributing any initial funds. This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund's performance."

Rush Limbaugh has also  zeroed in on "carried interest" as possibly being a problem. This could be because the recent raising of the taxes on capital gains from 15% to 20% may have been inspired by this tax loophole  That is, the rest of the country is now paying a penalty for this one taxing inconsistency.  Rush had in the past implied that this compensation represents a fair (interest) return on what these managers initially invested.  It most often isn't.  Or, if it is, is is not allocated according to what percentage their initial investment represents relative to the total hedge fund assets.  This, to me, is wrong ... and needs to be remedied.  The closing of this tax loophole is not going to balance the federal budget (bringing in just a few extra billion dollars), but this unfairness seems to be gnawing at Obama’s (and my) psyche … and should be fixed.   Then maybe we can drop the real capital gains tax rate back to 15%?  That would be fair.

So even though Obama seems to be biting the hand (Wall Street) that has fed him royally, I will support him on this one issue.  But I won't make it a habit.

Fewer Happy Returns

Mitt Romney was asked again in the South Carolina debate Monday night if and when he will release his income tax returns.  He indicated that, sometime in April after he has filed his 2011 taxes, he might consider such a move.  The question then presents itself -- why not also disclose his prior years?

My guess is that Mitt had been using the "carried interest" section of the tax code in years past (the same methodology that Warren Buffet uses to pay a lower tax rate ... around 15% ... than his secretary), and he plans quietly to abandon this practice in 2011.  He also hopes that showing his 2011 returns without this gimmick will satisfy for his critics.  Guess again Mitt!  If you have used this loophole in the past, it surely will come out (Obama's people do have access to your tax records) ... and probably just before the election ... as an October surprise.

So my suggestion to you Mitt is ... reveal everything now and put it behind you.  Say that, even though you (and Warren Buffet) have used this tax loophole, you now believe it to be improper and you will work for its repeal.  And, to show your sincerity, you will not use it for your 2011 tax filings, and, in the future, you plan on paying the normal statutory rate, not the carried interest rate (and maybe even urge Warren Buffet to do the same).

It might hurt your image for a while, but I don't think it will cost you the election.

Afterthought: Mitt Romney was on this AM's news saying (late last night) that his effective tax rate was close to 15% since most of his income has been from capital gains.  This suggests to me that he has indeed been using the "carried interest" methodology in his tax filings.  Now, as a result, our generally financially-illiterate media is starting the drumbeat against our lower 15% capital-gains rate.  If the fact that private equity firms and hedge funds have been, in my opinion, abusing "carried interest" to lower their taxes ... causes our equally-naive Congress to abolish a lower capital gains rate, then this would be a great tragedy.  They then would be doing what is best described as "pissing in the soup."  Please Congress, just eliminate the carried-interest tax loophole.

Ananomous posted a comment that appears to freeze things on this blog and, although I don't concur with it, I will post it here:

Nicholas Kristof writing in NYT recently: "President Obama is pushing to close this loophole. The White House estimates that this would raise $20 billion over a decade. But Congressional Republicans walked out of budget talks rather than discuss raising revenues from measures such as this one."

My comment in reply is:

Kristof worded this salvo very cleverly (I think it's called weasel worded) ... implying that the Republicans are great defenders of "measures such as this one." I strongly suspect it was mainly other things that they had objected to.  But still, I hope the Republicans do realize the political folly in defending "carried interest" tax treatments.

DEN posted the following comment (that also freezes things):

I am not against a 15% tax on investment income (i.e.,dividends). But I do object to the Fund Managers' characterization of their compensation for work as "investment" income which avoids paying the payroll taxes for SS and Medicare.