There is a big focus on tax reform in this country right now, and the GOP is gearing up for the show next week. Part of that is simply the desire of national GOP leaders and the White House to distract from other policy failures. But part of it is the country’s real thirst for changes in both how we administer taxation, and the specific taxes we pay.
It’s good that we are looking at tax reform. But it can also be a chance for the muckety-mucks to muck it up. So it’s a good time for a reminder: Don’t let the urgency of tax reform create new distortions by increasing taxes on capital gains through a blended rate.
Yes, the bad words: “capital gains.” The signal used by Democrats to initiate class warfare in tax debates does matter and will matter. But Republicans, especially on Ways and Means, need to remember that businesses and individuals (and the politicians who we put in office) can ill afford to let a tax hike through. But with the treatment of carried interest now being open to change, and judging by signs from both McConnell and Steven Mnuchin a change for the worse, we could be getting just that.
Under basic tax principles, carried interest income that is earned by selling a capital asset is taxed as a long-term capital gain if held for than a year. As it should be. That’s policy consistent with other long- term investments in capital assets. That’s not some kind of “loophole” as rhetoric would have you believe.
The Joint Committee on Taxation, for example, has long recognized this “flow-through” treatment as being “consistent with the general principles of partnership taxation.” It matches what would occur if carried interest partners invested directly in the asset.
Carried interest tax treatment is founded on two bedrock policies. First, that a preferential rate for capital gains is designed to reward risk taken in entrepreneurial spirit and to encourage investment, which drives growth. The second is that partnership profits should be taxed on a “pass-through” basis. Disturbing either principle would have harmful consequences for private equity funds, for start-up ventures and small businesses, for monetary interests in real estate and natural resources, and for other businesses and enterprises that involve carried interest and are dependent on personal efforts of the owners of the investment. To put it more simply, they crush the individual spirit and incentive to take risks and invest, which cuts at the very heart of our economic system.
Right now, we have policy-makers and legislators that want to make the tax code simpler, more fair, and more focused on driving economic growth. This is essential not just to economic recovery but to the very concept of our nation once again being the leader in economic growth and business. Adopting a blended rate applicable to carried interest capital gains would do none of that. Quite the opposite.
In fact, imposing an arbitrary blended rate on carried interest capital gains would add needless additional complexity to the tax code while reducing fairness, and would depress economic growth and investment.
What’s more, changing the character of carried interest, changing the theory upon which the tax operates, is just a foot in the door toward flat-out capital gains tax increases. If a carried interest tax increase proposal is enacted, then capital gains treatment for similar kinds of long-term investment may also be eliminated, ending decades of America’s commitment to fostering entrepreneurial risk-taking. Does that sound like a great idea? It isn’t, of course. We should be encouraging new investment.
Here in South Carolina, one our own, Rep. Tom Rice, is in a position to use this reminder. He’s pitching the Republican Tax Reform Blueprint. Considering the events of this year, it’s no leap of imagination to expect “deal”-making and horse trading to go on in the House in order to get tax reform through. What should not be traded, what is no deal at all, is changing the nature of capital gains and opening the door to tax increases that will hurt, rather than help, the growth and recovery of the American economy.