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Special Interest

March 15, 2010

James Surowiecki in The New Yorker:

It’s the time of year when a young man’s fancy lightly turns to thoughts of deductions and write-offs. One select group of Americans, though, has a more pressing tax-season task on its mind: preserving a lucrative loophole in the I.R.S. code. The provision allows money managers at privately held partnerships—like hedge and private-equity funds—to treat most of the money they make as capital gains rather than as ordinary income. That means that their income is often taxed at fifteen per cent, a much lower rate than it otherwise would be. In December, the House of Representatives passed a bill closing this loophole, the third time it has done so in three years. But it’s an open question whether the Senate will even take up the bill, let alone pass it.

In a typical private-equity fund, the managers get paid two per cent of assets as a regular fee, plus twenty per cent of the fund’s profits. They pay regular income tax on the two per cent. But on their share of the profits, which is called “carried interest,” they usually pay only long-term capital gains—even though they put up hardly any of the fund’s actual capital, most of which comes from outside investors. The difference in tax rates saves private-equity managers billions of dollars a year, and means that they pay taxes at a much lower rate than, say, your average lawyer. It also means that their taxes are lower than those of people who do the same kind of work, or get the same kind of pay, as they do. A general principle of good taxation is that similar jobs, and similar kinds of compensation, should be taxed the same way: otherwise, the government is effectively subsidizing some jobs over others. But the carried-interest tax break upends this rule. [More]

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