I've written here, and in my earlier blog, about the "carried interest" tax loophole. Here is an example, for those who enjoy hyperlinks. And here is another.
There is something new to say about this aging subject, involving both Messrs Camp and Norquist. And a question about idiomatic American English.
Before I get to any of that, though, a two-paragraph recap. Managers working with certain private funds [including but not solely hedge funds] receive much of their compensation in the form of a share of the profits of the fund they manage. The loophole in question is the fact that our tax law charges these managers at the capital gains rate, not the ordinary income rate, for that portion of their compensation.
Periodic efforts to close this loophole have failed over a period of years for a number of reasons. Largely they fail because the issue seems a technical one, discussed in technical language, and that sort of thing can get talked to death in smoke filled rooms.
Another ancillary reason why it hasn't changed, the Norquist pledge. Grover Norquist likes to get legislative candidates to promise that they will never vote for a tax increase, then he appoints himself arbiter over what counts as a "tax increase." It isn't always intuitively obvious after all.
At any rate, in recent days the Chairman of the Ways and Means Committee, Dave Camp (R-MI) put forth a tax plan that would eliminate the carried interest loophole. It would do so in a "revenue neutral" way (that is, the money gained from this change wouldn't go to lessen the deficit or do good deed -- it would be marked against revenue losses from other provisions in Camp's overall plan).
Nobody seems to hold out much hope of Camp's plan becoming law, but he is a Republican with conservative bona fides and the fact that he has turned against carried interest might be considered a watershed.
What makes it even more interesting is that Norquist is vacillating on the issue of whether the repeal of the carried interest tax would count as a tax increase. Of course, closing any loophole is an increase for the people who had been benefitting from the loophole. That, after all, is the point. But if Norquist says the proposed change is not an increase that'll create political cover for those Republicans who vote for it and who might later face a primary challenge.
So the world turns....
A non-rhetorical question: Is the capital gains tax, which provides that money earned by not working is taxed less than money earned by working, anything more than another example of the rich and powerful taking advantage of the rest of us? Or is it defensible as advancing the good of all?
ReplyDeleteThat's a very good question, Henry. I've addressed it at some length in the previous incarnation of this blog, Pragmatism Refreshed, in an entry for September 8, 2007.
ReplyDeletehttp://cfaille.blogspot.com/2007/09/capital-gains.html
The entry at Pragmatism Refreshed was a good answer, even though, ultimately, you leave the question open. You suggest that one way of dealing with the "bunching effect" of taxing several years' gain all at once would be to tax the gain each year as it happens. A problem with that is that, ultimately, the property might sell for less than the owner paid, so he might be entitled to a refund of all his prior annual tax payments. Why not deal with the bunching effect instead by allowing annual installment payments? The government could allow you to spread the total tax liability over the same number of years for which you owned the property.
DeleteI'll expand on my own plan a bit further, because it isn't really a matter of "installment payments." We want to figure out how everything could be treated as "ordinary income" without destroying the real estate market through the bunching effect, right?
ReplyDeleteAssume for purposes of discussion, that property assessments are quick, cheap, and reliable. The govt could in principle require every holder of real property to get an assessment as part of the usual rounding-up of facts and documents one does to prepare to make out the 1040 every year. If the value of the property had gone down that year -- a taxpayer would simply treat that as negative income, subtracting it from earnings that year. The more usual result (given the modern background assumption of inflation, and the historical trend regarding population growth and the demand for land) would be an increase in value, which would be an ordinary-income gain, since there is no longer a concern about bunching.
When you sell your house after, say, ten years, if the price is what the most recent assessment had indicated it should be, on this view NOTHING important for tax purposes has happened by virtue of the sale. The gain or loss reflected in that sales price has already gone into your calculations of your taxes year by year. Of course, if the market price turns out to be out of line of the latest assessment, then there is a gain or loss. But those would be relatively minor adjustments in that last year's tax bill, one way or the other. Again, on the assumption of reliable assessments. If we relax that assumption, yes, there are problems in this plan.
But it would seem a more plausible approach to solving the bunching problem than your proposal, which requires people to keep living and earning for a symmetrical number of years after selling their home. What of a couple that sells their Connecticut home after 40 years and moves to a condo in Florida? They should acknowledge ordinary income and pay on it over the next forty years? Even if they're both in their late 60s when they make this move? Or would the government look to the kids/heirs for the money?
The real point here is simply that getting rid of capital gains, and going to a system in which all income is ordinary income, would be a tricky thing, even if the problem were to be approached through policy wonkery free of the self-interest of the rich and powerful who make most of the cap gains.
To require a real property owner to hire someone to do an annual assessment seems to me an unreasonable burden. But it would be unnecessary, because the state (at least my state) does it every year in determining my property tax.
ReplyDeleteLet me see if I understand correctly. Under current law, the amount of capital gain determined by the profit or loss in dollars, without regard to the inflationary or deflationary value of those dollars. Is that correct? If so, then the couple who sells their home after 40 years could face a huge tax bill because of inflation, but they would pay it in today's inflated dollars.
You would change the law to use the assessment value to determine the amount of capital gains, and to do it every year. Under this approach, suppose that a house's assessed value increased year after year, and the owner paid taxes year after year. Then its value plummeted to below his purchase price. The loss he could take would, in effect, constitute his refund of the taxes he paid in previous years. And whether he sold the house at that point would be immaterial.
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ReplyDeleteMy suspicion is that the tax office's assessment value is understated in most suburbs, and overstated in most cities, for reasons related to the demographics of both locales. If so, then for the US Treasury to rely on those assessments would make the tax system a little bit more regressive than at present, and it probably wouldn't do so.
ReplyDeleteAs for the couple that pays back the money in inflated dollars -- yes, they do. But that wouldn't abolish the hardship caused by the bunching itself. And there is a long-term trend toward increasing real estate values in most places I can think of, simply because human population continues to increase, and human population is a decent proxy for the demand for living spaces. In Connecticut, there resided almost exactly 3 million people at the time of the 1970 census, and the number is close to 3.6 million acc. to the 2010 census. The demand increases and the supply stays constant with predictable consequences even notwithstanding inflation.
You do seem to have grasped the gist of what I've suggested, although the suggestion is somewhat tongue-in-cheek. The point of the thought experiment is just that I do think a lower capital gains level is defensible in largely middle-class countries where that aforesaid middle class often holds assets over long periods of time