MarketWatch: Taxing carried interest discourages investment
By Diana Furchtgott-Roth
President Obama’s proposal to tax certain returns on investments, known as “carried interest,” as ordinary income would raise taxes on some investment partnerships. It would bring in $14 billion over 10 years to Uncle Sam, but its disincentive effects on investment could be far greater.
That is because firms would make fewer investments, especially in the businesses or projects that most need capital. That, in turn, would further reduce economic activity, especially financing for private companies, innovators, and small firms getting off the ground.
Because taxing carried interest would put U.S. investment partnerships in real estate, venture capital, private equity, and others at a disadvantage relative to their international counterparts, some of this investment capital over time is likely to move offshore. Private equity assets under management now total $3.3 trillion, of which $2.3 trillion is invested capital and $1 trillion is callable capital reserves. Over 60% of these assets are owned by pension funds, which provide retirement income to millions of Americans.
Why take that risk? We want to encourage investment, and we want a simpler tax code.
Carried interest, also known as profits interest, is a net profit share — often in the range of 20% — received by general partners upon sale of a capital asset, whether it is a shopping center or a company. The remainder of net profit is distributed among limited partners, generally public and corporate pension funds, charitable foundations, endowments, individuals, and other equity funds.
Carried interest resulting from long-term capital gains in a partnership has always been taxed at long-term capital gains rates, the same rate paid by any investor who buys a capital asset, grows its value, and sells it at a profit. Now the top rate is 23.8%, up from 15% in 2012. Under the president’s proposal, all carried interest would be taxed as ordinary income beginning in 2015, at the top rate of 43%, including the Medicare and tax and phaseouts of itemized deductions and personal exemptions.
One result of the president’s proposal is that two investment partnerships, one of which had carried interest income and the other which did not, would face different tax rates when their assets were sold. This disparate treatment is poor tax policy.
Accountants and politicians could debate the pros and cons of these tax provisions for years. But they would all agree that the proposed change raises taxes, $14 billion over 10 years, according to budget documents released by the White House on Tuesday. With the economy and employment growing slowly, America needs more investment, not less investment. Congress and the president should lower taxes on capital and risky investments, not raise them, to encourage such investment.
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