Sen. Sanders’ (I-Vt.) and Secretary Clinton’s calls for higher taxes on private equity funds are to be expected in a Democratic primary. In the minds of their campaign advisers, that’s how they appeal to the party’s base. But why is Donald TrumpDonald TrumpFrench president rips Trump’s Paris comments By any other name: Revised Trump border rules will still be a Muslim ban Trump's first dinner out in DC: His own hotel MORE proposing similar measures to hike taxes on carried interest – which would hammer private equity firms – as part of his tax reform package? And, why would Sen. Ted CruzTed CruzBrietbart CEO reveals that Trump donors are part owners At CPAC, Trump lashes out at media Conquering Trump returns to conservative summit MORE (R-Texas), speaking at a campaign rally in Charleston, South Carolina, recently lament that “hedge fund billionaires pay a lower rate than their secretaries”?
These types of proposals and rhetoric might be temporarily expedient in some political settings, but treating carried interest as ordinary income is not a recipe for economic growth, nor will it make the tax code more efficient. Sanders and Clinton may not have these goals first in mind with their tax policy agendas, but Trump and Cruz certainly should.
Congress has established a lower rate for long-term capital gains for several reasons, among them the fact that longer term investments are riskier and also costlier to hold onto for the investor. It makes sense that the after tax return, therefore, should be higher, given these realities. Furthermore, the levy can act as a “double tax,” since the earnings that went into the investment were already taxed at ordinary rates. It’s also important to remember that unlike federal taxes on “ordinary” income, capital gains taxes are not indexed for inflation. Investors can get taxed on phantom returns.
Next, why should the tax code treat similar investors differently depending on how they’re incorporated? Treating carried interest as regular income would only apply to general partners in limited partnerships. Individuals and corporations engaging in the same activity would not see a higher rate under any plan to treat carried interest as ordinary income. It’s worth noting that this inconsistency shows up quite plainly in Cruz’s tax reform plan, which would cut the top rates by more than half but not for everyone.
Beyond the issue of arbitrariness in tax treatment, treating carried interest as ordinary income would hammer investments. While there are many types of private equity funds employing a variety of investment strategies, there is no question these types of investments have helped support innovative startups and provided critical capital to entrepreneurs. As Mary Petrovich, an operating executive at The Carlyle Group, noted in The Hill recently, "[In 2014] alone, private equity drove over $480 billion into the U.S. economy and is responsible for saving jobs, turning around companies, and helping companies grow." Do we really want less innovation and growth just to satiate the appetites of pandering politicians and class warriors?
Finally, raising taxes on carried interest is not a cash cow its proponents claim it to be. Estimates vary slightly, but this ill-conceived tax hike would yield between $15 and $20 billion in additional federal revenue over the next ten years. With the Congressional Budget Office forecasting revenue to top $42 trillion over the next decade, it’s clear that a higher tax on carried interest is not a budgetary panacea.
Conservatives should let Sanders and Clinton corner the market on bad tax policy cloaked in ugly class warfare rhetoric. Embracing higher taxes on carried interest will lead to weaker investments and will not seriously make a dent in the national debt. Conservatives ought to know this.
Packard is Policy and Government Affairs manager at the National Taxpayers Union.