Bad Schumer

Chuck Schumer's mostly a good guy, but his willingness to go to bat for the poor, put-upon multi-millionaire hedge fund manager certainly isn't part of that overall goodness. To reiterate, my basic view is that we shouldn't just make hedge fund managers switch from paying capital gains tax to income tax, but should actually just eliminate the differential treatment of capital income and labor income

Here's one proposal along those lines from Ron Wyden and here's a somewhat similar plan from the Center for American Progress. John Edwards' recently released tax plan is along these lines as well in terms of trying to give us more tax fairness. Schumer's bad behavior -- like John Dingell's climate change antics -- is a good reminder of how the political system works, when it comes to defending the interests of powerful, entrenched local groups, Democrats are usually about as bad as Republicans.

Comments

Nearly doubling the tax rate on capital gains sounds like a great way to send the bulk of the American securities industry overseas, and encourage international more investors to invest elsewhere.

As for Schumer, I'm not a fan, but his advocacy in favor of fund managers makes sense in that 1) they are a big part of the tax base and provide high-income employment to his constituents; 2) Schumer, who aced his SATs, is smart enough to know that someone has to pay the taxes to support his lefty redistribution schemes, and if he kills the golden goose there'll be no golden eggs to distribute to the poor, minorities, etc.

By the way: to be accurate, the issue isn't about hedge fund managers paying capital gains taxes but private equity fund managers, who claim the capital gains rate on borrowed funds. The political climate is ripe for these folks to get rapped on the knuckles, so I wouldn't be surprised to see a tax change specifically targeted to their business model. IMO, a legitimate change would be to apply the top income tax rate to private equity managers 'recapitalization dividends', where the company they buy out immediately takes on extra debt to pay back the PE guys' initial capital outlay. Let the PE guys wait until the new company is successful before they can cash out.

Posted by Fred | July 30, 2007 9:41 AM

Why wouldn't all the hegies then just move to London, or Hong Kong, the Caymans, or Bermunda?

It would seem like we'd kill the goose that layed the golden egg.

Posted by Jmo | July 30, 2007 9:50 AM

"Unintended consequences often occur when you do major tax work."

Chuck is correct and so are the two commenters above. While I believe this particular loophole should be closed since, in spirit, it's not really a capital gains issue, calls for the equalization of capital gains rates to income rates is simply moronic.
Capital gains rates are less because of the risk involved. If you wish to enhance the tax ramifications of capital gains, then it would only be fair to enhance the tax deductions available when you take a risk and things don't work out exactly as planned.

Posted by Fred Jones | July 30, 2007 10:02 AM

he raised more than $1 million from the booming private equity and hedge fund industries for the Democratic Senatorial Campaign Committee

Karl's official talking points are that if the hedge fund and private equity industry are going to be big Democrat donors, well, then, screw 'em. Let them have their preferred party tax 'em to high heaven.

However, since I work in the industry, and such a tax increase would hit my bottom line, Karl can get someone else to make that pitch.

On the larger point, I'd be equalize the capital gains and ordinary income tax rates if we ended the corporate tax.

Posted by Al | July 30, 2007 10:39 AM

Capital gains rates are less because of the risk involved.

Those amazing, risk-taking trust funders are deserving of preferential tax treatment. After all, if we don't favor the trust funders, won't the whole yachting industry, as well as the champagne and caviar producers, suffer? Trust-funders are, of course, the engine driving the US economy.

Posted by keatssycamore | July 30, 2007 10:44 AM

This CBO testimony on the taxation of carried interest was useful.

If carried interest was taxed at ordinary rates, I expect that these funds would either re-locate to more favorable tax havens, or document the fund as described here:

Some observers view carried interest as a mixture of compensation for management services and capital returns. For example, one can think of carried interest as an interest-free nonrecourse loan from the limited partners to the general partner equal to 20 percent of the partnership assets, with the requirement that the loan proceeds be reinvested in the fund. (A borrower is not personally liable for a nonrecourse loan, beyond the pledged collateral, which in this case is the general partner’s claim on future profits.)

To see how this example works, imagine a fund worth $100 million. With no direct capital investment, the carried interest entitles the general partner to the profits on $20 million (20 percent of the profits on $100 million is equivalent to the full profits on $20 million). It is therefore as if the limited partners have contributed $80 million to the fund and then lent the general partner $20 million to invest in the fund too, but without charging the general partner
interest on that loan.

This implicit loan perspective would result in treating carried interest somewhere between purely capital income and purely ordinary income. In particular, under current tax rules, the implicit interest on an interest-free loan would be taxed as ordinary income, with the interest rate set at the current rate on federal securities with the same duration as the loan. At the time the partnership sold its assets, any gain or loss to the general partner, after paying back the loan, would be treated as capital. In effect, then, this perspective would suggest that the component of carried interest attributable to implicit interest on the implied loan would be ordinary income and that the returns in excess of that implicit interest would be capital income.12

Obviously, that subtlety would be lost if the capital gains differential were eliminated for everyone.

Meanwhile, on the issue of tax fairness, don't software millionaires benefit from capital gains treatment when they sell their shares? Where is the tax equity amongst the mega-rich?

Posted by Tom Maguire | July 30, 2007 11:15 AM

Capital gains rates are less because of the risk involved. If you wish to enhance the tax ramifications of capital gains, then it would only be fair to enhance the tax deductions available when you take a risk and things don't work out exactly as planned.

Everything involves some of risk. The labor I invest might be wasted if the factory declares bankruptcy before payday. Or the home I buy with my wages could be swept away by a tornado or flood. The capital flight argument is reasonable, but the fairness argument is bunk--enhancing deductions for losses would do nothing but reward those with more to lose.

Posted by Consumatopia | July 30, 2007 11:26 AM

Consumatopia,

The fairness argument isn't bunk, and your examples are weak. Cap gains rates lower than income tax rates encourages ownership, risk-taking, and entrepreneurship, which creates jobs. You laboring in a factory doesn't create jobs, but investors putting up the capital for one does.

If you go to work for a factory, you are taking less risk than investors who invested in the factory. If the company goes into bankruptcy, your wages will be paid long before any investor gets any money; most likely, all common stock investors will get wiped out.

Also, most homeowners get don't pay any cap gains on the sale of their homes.

Posted by Fred | July 30, 2007 12:10 PM

Re "Chuck Schumer's mostly a good guy, "
---------------
ha ha ha ha. Gasp. cough.

Damm, don't do that , Matthew. I almost choked.

The super Neocons belong a propaganda front called Foundation for Defense of Democracy. Funded by billionaire Edgar Bronfman and some others, it's described at Sourcewatch:

http://www.sourcewatch.org/index.php?title=Foundation_for_the_Defense_of_Democracies

If you look at the "Board of Advisors" you see the usual suspects: Bill Kristol. Richard Perle. Charles Krauthammer. Zell Miller. Gary Bauer.

Plus you also see their little chum Chuckie listed. Nice company he's keeping.
Ref: http://www.defenddemocracy.org/biographies/biographies.htm

Some of you may recall my citations describing how pro-Israel billionaire S Daniel Abraham sabotaged Howard Dean's Presidential campaign in Iowa. What's interesting is that FEC records show a tidal wave of money subsequently flowing OUT of the DNC after Dean was made Chairman by the grassroots revolt. The money flowed INTO Chuckie's Democratic Senatorial Campaign Committee (DSCC ) pot.

Hey, anyone can call themselves a Democrat if they have enough money for the TV ads needed to win elections in urban areas. Just look at Joe Lieberman.

Posted by Don Williams | July 30, 2007 12:19 PM

It's easy to assert that the "American securities industry" would go overseas, but I'd need to see a much stronger analysis of the tax laws and the securities industry before I bought it or the idea that these hedge fund managers are even laying the golden egg. A large amount of the tax code is devoted to figuring out how to tax overseas investments and Americans and foreigners who have overseas investments.

Likewise, I don't know of any historical support for the notion that capital gains rates are lower to encourage ownership, and my own sense is that we'd be better off economically if the tax code didn't artificially try to encourage certain activities. (If you really think that risk is the touchstone for taxation, then why are wages taxed the same as secured loans? An employee certainly has more at risk than a secured investor.)

Posted by Doh | July 30, 2007 12:46 PM

I don't think we would lose investment if we raised the tax on capital gains on par with other forms of income. The issue I struggle with is the time difference on capital gains vs. income from wages/salaries

If I get a $100,000 capital gain on an investment I made 10 years ago, that $100,000 has been eroded by the inflation rate over that period of time. Don't you need to adjust for that? As much as I hate to admit it, I do think there is a "fairness principle" at work here to not overtaxing capital gains. Wages and salaries aren't eroded by inflation in the same way since you don't sign a 10-year contract with an employer at a fixed salary. We need to address the time element here.

Posted by David68 | July 30, 2007 2:00 PM

"If you go to work for a factory, you are taking less risk than investors who invested in the factory. If the company goes into bankruptcy, your wages will be paid long before any investor gets any money; most likely, all common stock investors will get wiped out."

I've heard of factory workers losing a limb at work, but I've never heard of a stockholder losing an arm at a board meeting. It's all in how you quantify different inputs and types of risk.

Posted by Reality Man | July 31, 2007 4:22 AM

Stuff like this and other Democrats acting like Republicans caused a good number of disillusioned Americans to vote for Nader in 2000 and throw the election to Bush.

Many partisan Democrats rail against Nader but it's okay with them that Shumer goes to bat for the super-duper rich.

Posted by Peter K. | July 31, 2007 4:37 PM