Obama’s Millionaire’s Tax

President Obama is proposing a special tax rate for millionaires.

President Obama is proposing a special tax rate for millionaires.

NYT (“Obama Tax Plan Would Ask More of Millionaires“):

President Obama on Monday will call for a new minimum tax rate for individuals making more than $1 million a year to ensure that they pay at least the same percentage of their earnings as middle-income taxpayers, according to administration officials.

With a special joint Congressional committee starting work to reach a bipartisan budget deal by late November, the proposal adds a new and populist feature to Mr. Obama’s effort to raise the political pressure on Republicans to agree to higher revenues from the wealthy in return for Democrats’ support of future cuts from Medicare and Medicaid.

Mr. Obama, in a bit of political salesmanship, will call his proposal the “Buffett Rule,” in a reference to Warren E. Buffett, the billionaire investor who has complained repeatedly that the richest Americans generally pay a smaller share of their income in federal taxes than do middle-income workers, because investment gains are taxed at a lower rate than wages.

Mr. Obama will not specify a rate or other details, and it is unclear how much revenue his plan would raise. But his idea of a millionaires’ minimum tax will be prominent in the broad plan for long-term deficit reduction that he will outline at the White House on Monday.

WaPo (“Obama to call for new minimum tax rate for millionaires“):

President Obama plans to call Monday for a new minimum tax rate on millionaires as part of a comprehensive rewrite of the U.S. tax code to force the wealthiest Americans to pay the same share of income in taxes as middle-class families.

In a twist on Obama’s long-standing assertion that the wealthy should do more to tame the soaring national debt, the proposal would target the top 0.3 percent of taxpayers, many of whom currently reap huge benefits from lower rates on capital gains and dividends, which form the bulk of their earnings.

While the idea has little chance of winning congressional approval, it could help shape a populist message for Obama and other Democrats heading into the 2012 presidential campaign.

According to a White House official who asked for anonymity because the proposal has not been announced publicly, Obama plans to call it the “Buffett Rule,” after Warren E. Buffett, the billionaire investor who recently stepped down from the Washington Post Co. board of directors. Buffett has long complained that the current system taxes him at a far lower rate than his employees.

While wages are taxed at rates ranging from 10 percent to 35 percent, investment earnings are taxed at 15 percent.

Republicans will decry this as “class warfare.” For once, they’ll be right. The sole purpose of this proposal, which has zero chance of being passed into law, is to leverage resentment against the most successful for political advantage.

If the purpose were to set up a political debate on the structure of our tax system and the need to bring in more revenues, there are all manner of serious ways to do it. For example, one could simply argue that capital gains should be taxed as ordinary income regardless of a person’s earning level. Or one could propose gradual but substantial ratcheting up of the payroll tax ceiling such that high earners would pay more into the Social Security system. Or one could target myriad tax deductions, ranging from corporate subsidies to write-offs for second homes, that predominantly favor wealthy business interests or mostly benefit high earners.

None of that would go over well with Grover Norquist, of course. Depending on the specifics, I might not support the changes myself. But they’d form a basis for a serious discussion about dealing with our national debt crisis.  Instead, we’re getting a cheap political stunt.

The primary reason that Buffett pays a higher effective tax rate than his secretary is that we have a FICA tax cap of $106,800. Because we are ostensibly using that money to fund Social Security retirement benefits, which are themselves capped, we only tax on the first $106,800.That means most of Buffett’s vast income is not subject to the FICA tax. We could certainly raise–or even eliminate–that cap. But unless we’re also going to offer enormous pensions to high earners (we currently cap payouts at $2346 a month) when they hit 65, we’ll destroy the illusion that Social Security is a retirement insurance program rather than a welfare system. And, frankly, if we’re going to do that, why not do away with separate FICA and Medicare taxes altogether and just raise the income tax rate?

As noted, the other difference between Buffett and his secretary is that, presumably, she gets all or most of her income in the form of wages. He, on the other hand, is mostly making money off of investment dividends. We tax those at different rates for a variety of reasons, the most prominent of which is risk. If money earned on investing in stocks were taxed at the same rate as guaranteed income, it would be a foolish investment indeed. Stocks go down. And money that’s made after investing  for years at a time should be deprecated ; otherwise, we could tax as “income” what amounts to breaking even–or even a loss–when inflation is factored in. Those rationales make sense for ordinary investors but are mostly irrelevant for people whose primary job is churning stocks, much less buying up companies and breaking them into little pieces.

We need more money to pay for the government that our elected representatives have given us over the past three decades and the enormous spending that we’ve committed to for the future. The notion that we can cut ourselves to a balanced budget–or even a sustainable one–is absurd. That means we’ll have to find new revenues. Naturally, those who are doing the best are going to get hit the hardest; that’s where the money is.

Instead of adding more gimmicks, like the odious Alternative Minimum Tax or this silly “Millionaires Tax,” let’s make smart, transparent reforms to the way we tax earnings. That’s more difficult than grandstanding, especially in the current political climate. But it’s what leaders are supposed to do.

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James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College. He's a former Army officer and Desert Storm veteran. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. john personna says:

    First thing, there is no reason why the number of income tax brackets should be six, but never seven. Indeed, as top income increases (and bottom income stays stubbornly at zero), more brackets make sense. The sixth bracket currently starts at $379K. Make the seventh at $1M. No problem.

    Second thing, is the term “millionaire” as meaning the “holder of a million” totally dead now? I suppose it is inevitable, with inflation, that a million in net worth isn’t much … but it does seem a tricky way for English usage to resolve the issue. So, millionaires are now people who make a million dollars each and every year? I’ve never been that … regular.

  2. Markey says:

    If the über rich don´t wanna pay 2-3% more in taxes, why don´t they just go on strike or leave the country? Get that libertarian “wet dream” thing into gear i say, Howard Hughes would want it that way.. 🙂

  3. john personna says:

    Oh, by the way, remember that Buffet said his special loophole was the “carried interest” rule.

  4. Racehorse says:

    Here is a plan that would be fair to everyone and balance the budget.
    Have a flat tax of 3% on everyone over 18 who has an income: students to billionaires. No loopholes – everyone pays: every kind of income except for investments. Our country needs to encourage investing and saving, not punish it. No deductions except charity and dependents. Those who are receiving government assistance – food stamps, housing subsidies, ss, free lunch, etc. will pay. Illegal immigrants will pay. This plan will more than double the tax base. It will erase the deficit in 3-4 years. It spreads the “pain” but makes it hurt a lot less for everyone, especially the middle class. Now who can argue with that ? (I am paying about 30% federal and state tax on a middle bracket income.)

  5. Rick DeMent says:

    If the purpose were to set up a political debate on the structure of our tax system and the need to bring in more revenues, there are all manner of serious ways to do it.

    The problem is that we don;t have a political system that responds to anything that resembles serious. Obama has to engage with the opposition on such nonsenses as “Death Panels”, “Socialism”, “Drill here … Drill now” the idea that a 3.5% tax hike on the wealthy is the single biggest threat to job creation known to mankind. Even your snark about “Class Warfare” is at best petty and at worse a great example of just how unserious the debate has become, )as if the president has nothing better to do all day then to get back at “the rich” a group of which he himself is a member). The Republicans have taken the debate to such a troglodyte level that the only way to move policy is to craft proposal’s that any moron can understand.

    Serious, nuanced policy has no place in a world where if it won’t fit on a bumper sticker it doesn’t exist.

  6. john personna says:

    Indeed the carried interest tax law does seem a special benefit for money managers and hedge fund managers. They make essentially commission, but are taxed as if it were a long term investment.

  7. Rick DeMent says:

    @Racehorse:

    No loopholes – everyone pays: every kind of income except for investments.

    You lost me right there, that is the camel’s nose under the tent. if your going to craft serious proposals then all income period no exceptions whatsoever. There is no reason investment income should be protected that is one of my biggest gripes against the tax code. It as if there just isn’t enough liquidity (which is the only thing that special tax rates really buy you).

  8. Rick DeMent says:

    @Rick DeMent:

    Oh and by the way I don’t know where you learned math but 3% flat tax will not come anywhere near paying for current spending let alone erase the deficit. It would net you about a quarter of a trillion dollars and that is without excluding investment income.

    Also, who gives a crap about the 30% marginal rate? I mean I’m paying that same thing on the high end of my income yet my effective rate was 11% last year. Federal Taxes are just not that high.

  9. Racehorse says:

    @Rick DeMent: How can we encourage investing and savings? Businesses need investors. Ok, tax the investment earnings – over a certain amount, such as $200,000 but don’t tax interest on savings. I always am amazed that I have to pay tax on my savings interest – it should be the other way around and counted as a deduction. That money is taxed twice – from my check and then on my income tax return.
    Weird, ridiculous.

  10. john personna says:

    @Racehorse:

    Here is a plan that would be fair to everyone and balance the budget.
    Have a flat tax of 3% on everyone over 18 who has an income: students to billionaires.

    You’ve suggested that, and we’ve said the math doesn’t work. Let me go look …

    The most recent year for which I can find “total wages paid” is 2001, so we’ll use that for both income and spending side.

    Total 2001 wages: $4,472,038,393,000

    3% of that is $134,161,151,790

    So how much income tax was collected under the old system, in 2001?

    Total 2001 income tax collected: $1,178,210,000,000

    So your plan brings in about 1/10th of what the government now receives. Can’t run on that.

  11. James Joyner says:

    @john personna: If we’re going to have a graduated rate system, there’s no obvious argument against six rates vice five. And, indeed, there’s a pretty good argument for treating $1 million differently than $100,000 given the decreasing marginal utility of the next dollar. Reflexively, I’d be okay with, say, 37% at 100k and 39% at $500k and 41% at $1M but not with, say, 37% at 100K and 80% at 1M.

  12. john personna says:

    @James Joyner:

    Actually, aren’t “brackets” artifacts of printed tax tables and hand-calculated returns? To the extent that we all use software now, we could make the increase uniform, a genuine continuous curve. That shouldn’t be too hard to present to voters, as a graph.

    (I mailed you a link to this story, that talks about the Darwinian view on marginal utility.)

  13. OzarkHillbilly says:

    @Racehorse:

    That money is taxed twice – from my check and then on my income tax return.

    Not so (as you admit):

    I always am amazed that I have to pay tax on my savings interest

    (reading comprehension is fundamental)(especially when writing)

  14. john personna says:

    @James Joyner:

    Reflexively, I’d be okay with, say, 37% at 100k and 39% at $500k and 41% at $1M but not with, say, 37% at 100K and 80% at 1M.

    As an aside, the only way to do such a what-if is with a 2009 filing database and a supercomputer at your elbow, you see how each tweak affects gross receipts.

  15. Tano says:

    @James Joyner:

    Reflexively, I’d be okay with, say, 37% at 100k and 39% at $500k and 41% at $1M but not with, say, 37% at 100K and 80% at 1M.

    So which of these two alternatives do you think will most resemble Obama’s proposal?

    I think the answer is pretty obvious. We will be lucky to get even the three different rates you lay out in your first example.

    In other words, when we get past all the absurd “class war” rhetoric, it turns out you will actually be supportive of Obama’s proposal???

  16. john personna says:

    (That story I linked above actually ends up endorsing a weird kind of consumption tax. I think it’s ok as a thought experiment, but flawed. In particular I distrust the idea that discouraging consumption by the rich leads to growth. In my area many blue collar folk work in yacht services.)

  17. JKB says:

    That means we’ll have to find new revenues. Naturally, those who are doing the best are going to get hit the hardest; that’s where the money is.

    Willie Sutton would be proud to see government taking on his motive. But the statement is a fallacy as the wealthiest, as their tax burden rises, have the motivation to hire people to scour the tax code for tax loss prevention. Is there a shortage of tax attorneys and accountants? Maybe this is a new jobs program for the surplus of lawyers we have?

    There is an upside as things stand now. The tax will drive money from the open market investment into things like municipal bonds and other tax-exempt investments. This will keep the borrowing costs down for struggling government entities. Problem, just as in the 1920s, investment in jobs producing, wealth increasing private enterprise will dry up. For some reason, the brainiacs in the White House and in the Dem party can’t seem to accept human nature, which will go to ridiculous means to keep from having another dollar taken from them even as the gleefully pay more from growing revenues when they are permitted to keep more of what they earn.

    Socialism, Keynesianism, punitive tax increases, when, oh when, will the brainiacs accept that betting against human nature is always a loser. They keep trying the same failed policies. The policies keep crashing when exposed to the real world with real human nature. But there seems to be a dearth of critical thinking about the failures and the futility of going against nature. Unless, you work to change men’s hearts as Jesus taught but as we’ve seen, work to debase Christianity and nature returns with a vengeance.

  18. Dean says:

    @john personna:
    Great catch on discouraging consumption by the rich. In addition to blue-collar yacht workers, when Congress waved its fingers at corporate execs for using private jets, thousands of union members lost their jobs when companies started canceling jet orders. We should encourage consumption. Confiscatory tax policies don’t do that.

  19. Fog says:

    Dean: In your opinion were the tax rates under President Reagan “confiscatory”?

  20. James Joyner says:

    @Tano: We don’t have the actual proposal in front of us. But it sounds like, instead of reforms that would have the impact of taxing high earners more, he’s talking about an AMT-type mechanism that would keep the rules as they are now and simply punish high earners by saying “yeah, but you make more than the threshold so now we’re going to impose a special penalty on you.”

    I’m not a fan of taxing income at all, preferring instead a consumption tax. But within the context of a bracketed income tax system, I can live with modest incremental brackets.

  21. James Joyner says:

    @john personna: I’m trying to wrap my head around the article. 2/3 of it is rather annoying set-up for an under-explored policy proposal.

  22. Eric Florack says:

    Oh and by the way I don’t know where you learned math but 3% flat tax will not come anywhere near paying for current spending let alone erase the deficit.

    And therein lies the dirty little secret. If, as I’ve been saying all along, it doesn’t solve the problem why do it? Because destruction of the rich is squarely in the goals of the left.

    I’ll say it again:

    When our government makes enemies of the corporations, the rich, and the profit motive, why would anyone be shocked when the economy ends up in the crapper?

  23. john personna says:

    @Dean:

    Wasn’t the jet thing a little bit the other way, though? I thought it was a subsidy, rather than a neutral freedom to spend their money on rich man toys.

    I’d certainly not ask for a yacht credit. 😉

  24. john personna says:

    @James Joyner:

    I think the set up is interesting. The reasons people need big SUVs and elk need big antlers are not unrelated.

  25. john personna says:

    @JKB: @Eric :

    Shrug. Do you first pay your bills, or do you first complain that life is not fair?

  26. Drew says:

    Thank you for a thoughtful piece on taxes. Its hard to find fault with much of anything, except the notion that people are out their buying up companies and chopping them into little pieces. To the (small) degree that happens there are usually serious considerations as to why to stay big or get numerously small. See the recent actions by Kraft, for example.

    As for carried interest, its a much misunderstood concept, and in fact it is not analogous to either a commission or a managment fee. Its easy to understand why people without understanding of the private equity business would not understand this, but I can gurantee you that guys like Krugman and Buffet do – which means they are just preening for the crowd, like Obama with this proposal.

  27. Social Security IS a welfare system, and there is no problem with that. If it was really treated as a welfare system it could be used more effectively to fight poverty against seniors.

  28. Drew says:

    PS –
    The reference to SS as welfare is apt. And although it was a piece on taxes, I say get along with it and means test benefits and recognize what it really must become under its current revenue and expenditure realities.

    I can only think of one motivation to not do so, and its political: to not admit the bait and switch – and lifelong retroactive tax – for it might make some question the veracity of claims about state programs in the future.

  29. Stan says:

    I’m shocked, shocked that the President thinks the Warren Buffets of this world should pay taxes at the same rate as their secretaries.

  30. jan says:

    @JKB:

    Socialism, Keynesianism, punitive tax increases, when, oh when, will the brainiacs accept that betting against human nature is always a loser. They keep trying the same failed policies.

    It’s so true about human nature never being factored into the psyche of the social progressives. For instance, when Clinton raised income taxes, early on in his presidency, his administration was surprised when projected revenues were off by two-thirds. Later he was said to have regretted raising taxes so high. And, when he then lowered the tax rate, revenues climbed and the economy grew more.

    However, I think the main issue to be raised, by Obama’s recent foray into economic solutions for our ailing economy, is to ask what his real goals are. Are they to present well thought out, genuine legislative avenues which have some chance of passing, given the differing philosophies in the Congress? Or, are they merely partisan vehicles, literally a disingenuous hat rack, on which he can then hang more divisive blame on the republicans, helping his own reelection chances in 2012?

    Furthermore, it is absolutely ironical that Obama calls his millionaires tax idea, the ‘Buffet Rule,” after his donation bundler friend Warren Buffet. This man has even less credibility after it was recently exposed that his own company owes somewhere in the neighborhood of 1 billion dollars in back taxes. It seems absurd that, on one hand, this billionaire chastises others for not paying enough taxes, when he has somehow by-passed paying what he rightfully owes the government himself!

  31. Ben Wolf says:

    We need more money to pay for the government that our elected representatives have given us over the past three decades and the enormous spending that we’ve committed to for the future. The notion that we can cut ourselves to a balanced budget–or even a sustainable one–is absurd. That means we’ll have to find new revenues. Naturally, those who are doing the best are going to get hit the hardest; that’s where the money is.

    Of course you have yet to elaborate on why a balanced budget should be a priority, Dr. Joyner.

  32. jpe says:

    If money earned on investing in stocks were taxed at the same rate as guaranteed income, it would be a foolish investment indeed.

    I don’t buy that a bit. People would still invest, because what else would they do w/ it? They’re not going to put it under the pillow (or in t-bills, the investment equivalent). Modern portfolio theory demands that people invest in equities.

    As for carried interest, its a much misunderstood concept, and in fact it is not analogous to either a commission

    It’s perfectly analogous to a commission: the fund manager gets X% of the profit brought in by dint of his services rendered. (I do taxes for some fund managers, so I’m fully acquainted w/ how it’s structured and how it works)

  33. jpe says:

    It seems absurd that, on one hand, this billionaire chastises others for not paying enough taxes, when he has somehow by-passed paying what he rightfully owes the government himself!

    That’s not what he owes; it’s what the IRS claims is owed. Very different, and I don’t see how a difference in opinion on the tax law should undercut Buffett’s credibility in the slightest.

  34. Ben Wolf says:

    Problem, just as in the 1920s, investment in jobs producing, wealth increasing private enterprise will dry up.

    Unfortunately JKB, your Cato link extolling how tax receipts expanded upon cutting taxes in tne twenties suddenly stopped its analysis in 1928. Funny that, because in 1929 the massive credit, stock and real estate bubble created by reducing taxation and government spending exploded and revealed the economic growth from supply-side economics as the illusion it was.

    Apparently for these people the depression occuring at the end of that bubble was somehow the result of sudden, massive socialism gaining control after eight years of free markets. It must have snuck in through the pet entrance in the economy’s laundry room.

  35. Ben Wolf says:

    I don’t buy that a bit. People would still invest, because what else would they do w/ it? They’re not going to put it under the pillow (or in t-bills, the investment equivalent). Modern portfolio theory demands that people invest in equities.

    +100 for the correct answer. Capitalism does exactly what it was designed to do: it creates capital, but in time it creates far too much to be absorbed in bonds or “real” other safe havens. The wealthy will continue to invest regardless of the tax rate because that much capital has nowhere else to go.

  36. Drew says:

    “It’s perfectly analogous to a commission: the fund manager gets X% of the profit brought in by dint of his services rendered. (I do taxes for some fund managers, so I’m fully acquainted w/ how it’s structured and how it works)”

    Let’s see if you do understand. What activities are paid for by the management fee, and what activities are rewarded by the carried interest?

  37. ponce says:

    The sole purpose of this proposal, which has zero chance of being passed into law, is to leverage resentment against the most successful for political advantage.

    This has got to be the weakest argument the right wing middle class defenders of the rich (why they do it is a mystery, maybe it’s a genetic thing) make.

    A large majority of Americans support taxing the rich more as one step towards solving economic problems.

    And there is no reason a hedge fund manager making $2 billion a year should be paying taxes at a lower rate than middle class Americans.

    And if the Republicans vote it down I’ll wager it will cost them control of the House next year.

  38. jpe says:

    Drew, I’m quite sure I know more about how it works than you do. I should be quizzing you, not the other way around. So, w/ that said, why don’t you tell us about how the carry had been deferred and how the enactment of IRC 457A alters the ability to defer the carry. Perhaps you could also tell us about the Diamond case, and how there’s no question that the carry is received in exchange for services, but that the question is only one of valuation. At that point, we can discuss how the proposal is an appropriate response to Diamond.

  39. jan says:

    @jpe:

    That’s not what he owes; it’s what the IRS claims is owed. Very different, and I don’t see how a difference in opinion on the tax law should undercut Buffett’s credibility in the slightest.

    Considering that Warren Buffett owns a sizable chunk of Berkshire-Hathaway stock, he also has a sizable say as to how ethically this company conducts itself.

    For an influential man like Warren Buffett, who openly shills for Obama’s policies, including magnanimously becoming Obama’s symbol of what the ‘rich’ should be doing, he does indeed lose credibility when his company has been fighting the IRS for almost a decade so it can avoid paying higher taxes.

    Furthermore, according to Bershire-Hathaway’s own annual report, they seem to agree that more taxes are owed.

    Americans for Limited Government researcher Richard McCarty, who was alerted to the controversy by a federal government lawyer, said, “The company has been short-changing the tax collection agency for much of the past decade. Mr. Buffett’s company has not fully settled its tax bills from 2002-2009. Yet he says he’d happily pay more. Except the IRS has apparently been asking him to pay more going on nine years.”

    In Berkshire’s annual report, as reported here, it goes on to say:

    “At December 31, 2010… net unrecognized tax benefits were $1,005 million”, or about $1 billion. McCarty explained, “Unrecognized tax benefits represent the company’s potential future obligation to the IRS and other taxing authorities. They have to be recorded in the company’s financial statements.”

    He added, “The notation means that Berkshire Hathaway’s own auditors have probably said that $1 billion is more likely than not owed to the government.”

    BTW, who else but the Internal Revenue Service (IRS) acts as the government’s oversight in telling people what they owe? Or, is someone, of Buffett’s stature and ‘tightness with the Obama administration, exempt from their long arm of “pay us now?”

  40. anjin-san says:

    Class warfare Jan? Can you do no better?

  41. jpe says:

    @ Jan: you really shouldn’t rely on MSM or blogs for reporting accounting correctly. If you actually go the report, you’ll find that it says the exact opposite of what Human Events reports. Per the report, they believe that the deductions they’re claiming are “highly certain.”

    Remember, try to be a little skeptical when you read media, and if the source is provided, double check it.

  42. jpe says:

    This is fantastically wrong:

    McCarty explained, “Unrecognized tax benefits represent the company’s potential future obligation to the IRS and other taxing authorities.

    Not even close. Tax benefits are deductions and credits that will reduce tax in the credit. It’s not potential future obligation, but future reduction of liability.

    It’s almost startling how terribly reported that Human Events piece is.

  43. jpe says:

    Scratch that last comment. It turns out I’m the one that’s fantastically wrong.

  44. ponce says:

    Class warfare Jan? Can you do no better?

    It is a rather lame defense of the rich.

    Perhaps that most curious of American political creatures, the working class right wing Republicans who cry themselves to sleep each night worrying about how much tax billionaires are paying, are starting to develop a sense of shame.

  45. jpe says:

    (everything I said about the Human Events piece? Wrong. We regret the error)

  46. jan says:

    @anjin-san:

    Class warfare Jan? Can you do no better?

    …a non-sequitur……

  47. Drew says:

    Diamond? Are you serious? A case from what, 1970 or something is difinitive? Further, if I recall correctly that had something to do with some guys who brokered a loan. The case was in no way dispositive as to whether what is provided by a PE firm is “services” or whether thay are participating in capital appreciation. And the IRC if I recall correctly deals with deferral issues, but not characterization of the tax nature of profits interests.

    But why don’t you stop obfuscating with accounting citations and deal with the real economics of the matter, and the very longstanding tax treatment??

    First of all, the commision reference is incorrect in that it is a simple broker payment, say to buy or sell a security paid by buyer or seller because they don’t have a seat or licence. It has nothing to do with carried interest. Restraint of trade, maybe, carried interest, no.

    Second, as you must know, PE fund managers receive a management to run the affairs of the firm: pay salaries, rent, utilities, acctg and tax audits, SEC compliance, subscriptions and research etc. That is, doing exactly what professionals in a public security mutual fund does. And if there is a residual the members of the PE firm take it in income and guess what……………pay oridinary income rates on it. This is the proper analogy and the OI treatment only proper.

    However, carried interest is a different cat. At the highest level, the business of assembling and managing a PE portfolio IS the business, requiring very intimate and active participation, just like a manufacturing or business services company. Extensive travel to locate and woo investment opportunities. Months (like 4-6) of managing the corporate, equity and debt documentation. Board governance, collaborating with management in strategy setting, hiring and firing of executives, dealing with raw materials sourcing, competitive and legal issues as they arise. Building the company through add-on acquisitions or channel building and managing banking relationships. And then running a sale process generally measured in 9-12 months. That’s completely different from a mutual fund manager who places orders at the trading desk while sourcing opportunities from The Wall Street Journal and doing research. In fact, its running a business.

    To declare this not running a business with the attendant potential for capital appreciation, or just a fee for service activity, is like saying a guy who runs a plastic injection molder making pallets just brokers plastic resin into pallets and deserves a fee for service rather than the benefit of capital appreciation for building his business from the time he/she starts the business until the time he/she winds it up. . .

  48. Drew says:

    Time to watch the Bears.

  49. john personna says:

    On phone – do you need your own money at risk to earn carried interest, or can it all be OPM?

  50. James Joyner says:

    @Ben Wolf: A balanced budget per se isn’t that big of a concern. During times of contraction or other major crisis, such as a world war, deficits make a hell of a lot of sense. But a permanent policy of borrowing for ordinary needs leads to a crisis in and of itself, with service of the debt consuming an ever larger share of the pie.

    My druthers would be a substantially smaller government, at least at the federal level. I’m in a small minority,apparently. Which means we have to get revenues into rough alignment with our appetite for government.

  51. john personna says:

    @James Joyner:

    But a permanent policy of borrowing for ordinary needs leads to a crisis in and of itself, with service of the debt consuming an ever larger share of the pie.

    That’s what I was trying to get across above, when I said “Do you first pay your bills, or do you first complain that life is not fair?”

    There are “druthers” but there is also a $14T debt.

    In 2011, I’m kinda getting tired of the assumption that the debt will just go away, if we cut taxes now (especially on the rich) and worry later. The spending cuts have been in the mail for at least a decade.

  52. Moderate Mom says:

    As everyone argues about this, what no one is addressing is the lack of specifics. Obama proposes a “Buffett Tax” on millionaires, but with not a single specific. In fact, the Times article even says he’ll toss it to the Debt Commission to figure it out. Are we talking about an increase in tax rates on wage income? Is it an increase in the capital gains rate? Is a “millionaire” defined by their annual income, or their net worth? Who the hell knows, because, as usual, Obama just tosses some vague idea out, but refuses to detail specifics. Just like the Jobs Plan. He says what he wants to do, and how much it will cost, repeatedly saying it’s paid for, but punts on the details of how it will be paid for.

    Just another campaign stunt in his never ending class warfare arsenal. This guy really does suck.

  53. john personna says:

    @Moderate Mom:

    FWIW, I think a lot of people are trying to hold the line, before any bill is introduced.

  54. Drew says:

    “On phone – do you need your own money at risk to earn carried interest, or can it all be OPM?”

    Its a nice fishing argument, but not that relevant. The so-called GP-Commitment (the money the GP’s must put into deals varies wildly by fund and what is negotiated with LP’s. As a general proposition its 5% to 40% (for Fund IV, V, VI types) of the total fund committments. So that’s the first point, its negotiated with the LP’s. Second, the guiding principle on GP Commitment is “does it matter” to the GP? 10% to 20% of total net worth is typical. I wonder how many people put 15% of their net worth at risk in a mutual fund. (Hint: zero).

    But think about an owner of a widget manufacturer who puts $100K into a venture but now has built a business worth $10MM. $9.900MM is the house money. Do we deny cap gains to the widget company owner at sale based on it being house money? No. We base it upon the business of building the capital account.

    This argument has gotten silly. Denial that this is just all about politicians grasping at a perceived tax revenue source at the expense of a politically disfavored group is to fail a basic IQ test. And if we want to eliminate capital gains treatment on one group who provide “investment services” why not eliminate capital gains treatment on a business owner who provides “managerial services?” Good policy if you want to eleiminate jobs……..oh, wait.

    Take off your blinders and envy people, and think like an economist or businessman.

  55. anjin-san says:

    …a non-sequitur……

    One that you tend to pull out of the hat anytime a Democrat says anything that could be interpreted as being against the interests of the rich.

  56. jpe says:

    Are you serious? A case from what, 1970 or something is difinitive?

    That case from 1970 or something is why carried interest gets the treatment it does. Apparently you know about as little about the topic as I assumed.

    At the highest level, the business of assembling and managing a PE portfolio IS the business, requiring very intimate and active participation, just like a manufacturing or business services company. Extensive travel to locate and woo investment opportunities.

    What you’re describing is “sweat equity,” which is the service rendered in exchange for that income. It is, nonetheless, service, not capital put at risk.

  57. john personna says:

    @Drew:

    It matters if we think that “investment” is about money at risk.

    And, I thought that some of these guys were founding hedge funds, totally with OPM (other people’s money) and then taking the “carried interest” reporting.

    To the extent that people have genuine money at risk, for long terms, then yes those are genuine long term investments and long term capital gains.

  58. jpe says:

    On phone – do you need your own money at risk to earn carried interest, or can it all be OPM?”

    Nope. In fact, the receipt of the carried interest – the right to profits from the endeavor – is considered to be worth zilch. Typically the manager will have some amount of capital in the fund – for a GP interest typically around 1% – but it’s not necessary. The profits interest is attributable to the services rendered to the partnership.

  59. john personna says:

    @jpe:

    Thanks jpe. So I’d say either this loophole is too large, and granted to non-investors in error, or it is a “friends and family” tax loophole by congress to … friends and family.

  60. jpe says:

    To the extent that people have genuine money at risk, for long terms, then yes those are genuine long term investments and long term capital gains.

    They’d get that treatment for the capital they invest; what the carry is, however, is long term cap gains treatment for the services they render. Say you give me a million dollars and say, “invest this and you can keep 20% of the gains you make.” I invest 100k alongside you, and put the 1.1MM in a partnership. If I make $110k in, say, qualified dividends that first year, I’ll get 10k of qualified dividends taxable to me due to my $100k investment, another 20k in QD attributable to my carried interest (which is the 20% of profits on your capital that I get for running the fund), and you’ll get the rest. The tax question is how we should treat that $20k I get from you for investing your money.

  61. jpe says:

    I think that’s right, John. It’s based on the pretty wacky notion that a profits interest is worth zero. I guess it’s impossible to correctly value a profits interest when received, since the value of it depends on what the fund will make in the future, but there’s no reason it has to be valued at the time it’s received. Since the economic value of the interest is the net present value of all future distributions attributable to the interest, we can appropriately tax the receipt of the carried interest by taxing each distribution attributable to it as ordinary income (no one that understands the carried interest denies that the receipt of the interest is ordinary income). And that’s exactly what the proposal does. So it’s the rare tax provision that actually raises revenue and correctly captures the underlying economics of the transaction.

  62. Ben Wolf says:

    @James Joyner: A reasonable response. I strongly disagree with your characterization of borrowing and debt servicing as unsustainable, but otherwise I think you’re roughly correct.

  63. samwide says:

    Today’s exam question, class: Is the United States on its way to being evidence for Michels’s Iron Law of Oligarchy? Discuss. If you wish, you may incorporate date from Alex’s post, “Soaking the Rich” in Perspective, above.

  64. Racehorse says:

    @john personna: well, are you figuring in the millions who pay 0 taxes? Many of whom make $1 million +.

  65. Drew says:

    “It matters if we think that “investment” is about money at risk.”

    Or opportunity cost. How are they different?

    “And, I thought that some of these guys were founding hedge funds, totally with OPM (other people’s money) and then taking the “carried interest” reporting.”

    That is simply factually incorrect.

    “To the extent that people have genuine money at risk, for long terms, then yes those are genuine long term investments and long term capital gains.”

    How do you differentiate seed money at risk in a widget maker, and GP committment at risk?

    You and I cross swords often, jp. But be careful of this character, jpe; a weak and local yocal argumenter if I’ve ever seen one. (Unless, of course, as is your propensity, to change names, and YOU are jpe.)

    He may represent Dewey, Fleecem and Howe. But our advisors on this matter are the M&A practice at Deloitte, and McGladrey; legal at O’Melveney and Myers etc. That’s as good as it gets.

    Forgive me if some guy quoting Diamond from 1970 (41 years!!??) as some guiding principle I find a fraud, or at least some politically driven policy nut.

  66. Drew says:

    “They’d get that treatment for the capital they invest; what the carry is, however, is long term cap gains treatment for the services they render. Say you give me a million dollars and say, “invest this and you can keep 20% of the gains you make.” I invest 100k alongside you, and put the 1.1MM in a partnership. If I make $110k in, say, qualified dividends that first year, I’ll get 10k of qualified dividends taxable to me due to my $100k investment, another 20k in QD attributable to my carried interest (which is the 20% of profits on your capital that I get for running the fund), and you’ll get the rest. The tax question is how we should treat that $20k I get from you for investing your money.”

    How about if we reject this shallow, intellectually light and false proposition, and tell every prospective entrepreneur…………….the only way you can get capital gains treatment is if you invest $300MM (BTW – a small PE fund size). We will get zero investment.

    Its becoming transparently clear that jpe suffers from profit envy, because he’s a simple accountant, and not a businessman and PE partner. Look, come clean, jpe, you don’t have the balls or the talent to step into the killing fields of the PE world. If its such easy and and ill gotten money, take your panties off and raise a fund. I’ve met so many all talk, no action dweebs like you.

  67. jan says:

    @Drew:

    You’re confusing them with knowledge and facts. Some simply can’t process that without a good dollop of mismatched ideology, keeping their fingers crossed that no one will notice.

  68. jukeboxgrad says:

    john:

    I mailed you a link to this story, that talks about the Darwinian view on marginal utility.

    Thanks for that link. I think what Frank is saying is quite important. I have also tried to explain this.

    Our tax policy is messed up because we don’t understand the evolutionary relationship between sex and money. Money is a positional good. A certain amount of income (and wealth) inequality is functional, but when it becomes extreme the result is extreme waste.

    The reasons people need big SUVs and elk need big antlers are not unrelated.

    This is exactly right. When rich people buy a bunch of extra houses they hardly use, that’s just like those big antlers.

    I distrust the idea that discouraging consumption by the rich leads to growth. In my area many blue collar folk work in yacht services.

    When that money is no longer being spent on yachts, it doesn’t disappear. The premise is that it ends up being applied to a purpose that’s less wasteful. Picture that money being invested, or picture it being taxed and then used to build infrastructure.

    james:

    I’m trying to wrap my head around the article.

    My longer explanation that I cited might help you understand Franks’ shorter explanation.

  69. Drew says:

    jan –

    Oh, they get it allright. But so much better to blame their own lack of economic success, or envy of others success, in notions of meanies and bullies, and never look in the mirror and ask “why didn’t I work that hard or take those risks; why do I care that other’s did and reap the rewards?”

    Better to invent theories of ill gotten gains. But in the dark of night, they know. And what’s worse, they know you and I know. That’s why they hurl the invective.

  70. Drew says:

    PS – all cloaked in theories of caring……………………and yet the invoked societal ills never get resolved.

  71. An Interested Party says:

    But so much better to blame their own lack of economic success, or envy of others success, in notions of meanies and bullies, and never look in the mirror and ask “why didn’t I work that hard or take those risks; why do I care that other’s did and reap the rewards?”

    Ahh, so everyone who is wealthy worked very hard to create that wealth and did it all by themselves, eh? Following that same logic, I guess everyone who is poor deserves to be poor because they have done nothing to escape poverty…

  72. john personna says:

    @Drew:

    Drew, it should be obvious to the reader when you don’t try to make a case, and when you instead try to “bigfoot” an argument. You are “the only one who can know” and so “always right.”

  73. john personna says:

    (And reading, and rereading, your responses, I don’t see you engaging the central idea at all.

    That is that carried interest, with no principal at risk, is like many other commissions on business.

    You are retreating into other details rather than recognizing that this is a special benefit for financial, as opposed to other kinds of managers.)

  74. john personna says:

    @Racehorse:

    well, are you figuring in the millions who pay 0 taxes? Many of whom make $1 million +.

    Of course. I gave you total income tax receipts.

  75. Neo says:

    When Bill Clinton passed a “millionaires tax” back in 1993, there was an exception for Hollywood celebrities and sports figures.

    When Barbra Streisand sang at the MGM Grand in 1993, the head of MGM was paid less for the year than she got for a week. Guess who had to pay the millionaires tax ?

    Of course, the unintended consequence of that “millionaires tax” was that corporate executives capped their salaries at $1 million, and made up the rest with stock options. This lead to the largest transfer of equity in the history of the world, as these executives acquired equity from the stockholders worth roughly 10% of the Fortune 500 through stock options over the next 10 years.

  76. Eric Florack says:

    @john personna: My bills are paid.

  77. Drew says:

    “Drew, it should be obvious to the reader when you don’t try to make a case, and when you instead try to “bigfoot” an argument. You are “the only one who can know” and so “always right.””

    I’m the only one who actually made a case based on the business and economic realities. That, of course, is because I’m actually in the business, and briefed by top flight talent on the relevant issues. Others, including you, were reduced to invoking childish economic jealousies. Too bad. I’m sorry that your ignorance and limited perspective renders you incapable of responding with substance, although that has never prevented you from flapping your lips incoherently in the past………………..and then desperately searching for exculpatory responses.

    Carry on.

  78. jpe says:

    If its such easy and and ill gotten money,

    This is sheer projection. I never said it was easy, nor did I say it was ill gotten. That you’re inserting this sort of childishness into a technical question about tax treatment tells us that you just don’t have anything interesting to say.

  79. jpe says:

    How do you differentiate seed money at risk in a widget maker, and GP committment at risk?

    We’re not talking about the GP commitment at risk. They typically do invest some capital alongside the LPs (which you may or may not have known), but that’s not what is being discussed. In every proposal that would treat carry as OI, any capital actually invested would retain its the pass-through character. For the umpteenth time, we’re talking only about the profits interest that doesn’t result from a contribution of capital (which we call “the carry,” in case you’ve gotten confused in the course of this thread).

  80. samwide says:

    The theme of envy on the part of his opponents constantly crops up in Drew’s postings:

    Others, including you, were reduced to invoking childish economic jealousies.

    But so much better to blame their own lack of economic success, or envy of others success

    Its becoming transparently clear that jpe suffers from profit envy

    Take off your blinders and envy people

    There’s a whiff of fear (and maybe self-loathing) in all that. Much easier to reject someone’s arguments because of his or her (supposed) base motives than consider the arguments might have merit. Much easier on one’s internal dialogue, too.

  81. john personna says:

    @jpe:

    For the umpteenth time, we’re talking only about the profits interest that doesn’t result from a contribution of capital (which we call “the carry,” in case you’ve gotten confused in the course of this thread).

    That’s it in a nutshell. We certainly aren’t saying these managers don’t deserve their share of gains … only that they don’t deserve a special tax advantage.

  82. john personna says:

    @Eric Florack:

    @john personna: My bills are paid.

    You don’t feel the $14T debt is in any way yours? Not even in fraction?

  83. Anderson says:

    @James Joyner: What was the top rate under Eisenhower? 50%?

  84. James Joyner says:

    @Anderson: I think it was actually 70%. I don’t think a high rate is necessarily class warfare, although it certainly can be. To me, it depends on how it’s sold.

    I actually wrote an extensive piece on this a couple years ago: “Class Warfare: Framing the Debate

  85. jukeboxgrad says:

    The top rate in 1952 and 1953 was 92%. Also see here.

    The top marginal rate was 63% or higher from 1932 to 1982. It was 91% or higher from 1950 to 1963. We are now in an era of much lower rates, and this began with Reagan.

  86. Eric Florack says:

    @john personna: How did the subject shift so violently to this? Was the topic we were on so obviously a lost cause?

  87. BAKARI RASHIDI AKIL says:

    @john personna: @john personna: The milionaires and billioniares who are progressive enough- should send at least 15% of their projected income to the IRS REFERENCED TO pay for the$ 450
    Billion Warren Buffet Act. I am a common man and this is just too simple. We could win in so many ways by allowing the progressive people to take the initiative.

    Bakari R. Akil Sr.

  88. Steve says:

    @Racehorse:

    Please, if you could provide any documentation on anything you just said, I’d appreciate it. I understand that 50% pay no income tax (but do pay payroll tax, which proportionally for them is a large burden). But even getting these people to pay income tax would not be that large a sum of money, far from enough to fix our problems, because that’s how bad income inequality is in this country. Sure, broaden the tax base, but there’s just not that much money there.

  89. jukeboxgrad says:

    I understand that 50% pay no income tax

    This complaint (that I realize was raised by others, not you) is quite ironic, for reasons that are nicely explained here:

    … one of the main reasons lower middle class families don’t owe net taxes is the Bush tax cuts which cut their rates along with everyone else’s.

    I don’t know about you but I don’t remember any of these protests about how the bottom third in the income distribution were not paying their fair share when Bush’s tax cuts were originally put to a vote. Of course, raising that objection would have made it too obvious as to what was really going on — Republicans do not, in fact, care about cutting taxes for middle class people.

    They will pass middle class tax cuts only when it gives them political cover to also pass cuts for the people in the top brackets.