Tax reform, like a woman, must be courted, not taken by storm.
The challenged is exacerbated by the tax motto of Congress articulated by the late Senate Finance Committee Chairman Russell Long, Louisiana Democrat: “Don’t tax you, don’t tax me, tax that fellow behind the tree.”
Pending tax bills in Congress would reform the longstanding treatment of so-called “carried interest” as capital gains. They enjoy preferential tax treatment over ordinary income like salary or wages. At present, capital gains are taxed at 23.8 percent, whereas the highest marginal rate for ordinary income is 39.6 percent.
The reform provisions would confine capital gains treatment to the profits earned from assets held for three years or more.
Carried interest represents the profits — typically 20 percent — earned by hedge fund managers, private equity managers, venture capitalists or real estate investors. Preferential tax treatment is said to be justified to encourage the private investment that fuels economic growth and job creation.
That argument seems incomplete. It might equally be said the interest earned on savings accounts should be tax exempt to encourage savings that financial institutions use to lend for commercial expansion.
The tax code, however, is not informed by intellectual or philosophical tidiness, but by raw political power. It is idle to support or oppose a tax provision based on high principle.
Even when perfumed, capital gains treatment for carried interest carries the aroma of crony capitalism. During his presidential campaign, Donald Trump promised to eliminate that tax preference entirely. And it is difficult to imagine hedge fund managers abandoning their ultra-lucrative jobs simply because all or a substantial portion of their envied income were taxed at ordinary income rates.
The good should not be sacrificed at the altar of the perfect. The three-year carried interest compromise in pending tax bills would be a commendable step towards tax equity.
That intangible is a cornerstone of our tax system. It depends overwhelmingly on voluntary compliance. The IRS is short-staffed. Only a handful of tax returns are audited. If the tax code is popularly perceived as tilted toward the rich or powerful, voluntary compliance will diminish along with government revenues. It should be recalled that tax preferences or immunities for the nobility and clergy sparked the French Revolution.
What counts in politics as in life is less where you’re at than where you’re going. On that score, rolling back the preferential capital gains tax treatment for carried interest is a welcome sign. New Congresses will provide new opportunities for greater tax equity.
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