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Capital Gains: It Shouldn't Matter Whose Capital Is at Risk

Bill and cash
Bill and cash

An email I just received conveys an extremely common reaction to my arguments for preserving the capital gains tax treatment of carried interest:

“If the hedge fund managers have their own capital at risk, I get it, 15 percent. If not, then pay what everyone else pays on ordinary income for services rendered.”

I’ll admit that I just don’t get why this makes sense.

Why should investment profits that would get capital gains treatment be taxed more heavily just because the original source of the capital wasn’t the person doing the investing? Why should the source of the capital be the crucial test, rather than the activity of investing?

To put it differently: What public policy goal are we achieving by changing the tax treatment of carried interest?

The call for taxing hedge fund managers at higher rates is often put in class war terms. For example, the same emailer goes on to ask:

What is ‘unconscionable’ is that [hedge-fund manager John] Paulsen pays 15 percent on billions and his maid pays whatever marginal rate she pays, likely in excess of 15 percent, depending on how well Mr. Paulsen pays her. What part of this don't you get?

But eliminating the capital gains treatment for carried interest doesn’t make the world any fairer. In fact, it just creates a new privilege for the already well-off. Only those who have already accumulated capital get the lower tax rate—those who need to contribute their labor to attract capital to invest would not. The “idle rich” get the break—the working investment professional would not.

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