Compromise on Tax Reform Strikes Balance on Carried Interest

As Republicans gather momentum and votes in Congress to enact a much-needed tax cut bill, they are running up against the politicians who see tax reform as a way of sharpening their rhetorical swords to engage in class warfare. One of the primary targets of the class warriors is the so-called “carried interest” tax provisions of the tax code. House Republicans led by Ways and Means Committee Chairman Kevin Brady (R-TX) has found a way to reform the tax while ensuring the investment will continue to flow into the economy.

Carried interest is the tax paid by members of partnerships when profits are distributed. It qualifies as capital gains and it is taxed at the 23.8 perfect rate rather than the nearly 40% income tax rate. For politicians like Bernie Sanders and Hillary Clinton, this constitutes a massive “loophole for the rich.” In fact, some liberals want to do away with the capital gains tax rate all together and just tax everything at the income tax rate. Carried interest has become the first step in the battle to do that.

Since Congress, in its infinite wisdom, passed the income tax, investment has been taxed at a lower rate than income. The reason is obvious, without investment the economy dies. To encourage taking risk and making investments in the country, investors are taxed at a lower rate.

Writing for The Hill, Jerry Rogers notes that, “The Tax Foundation explains that “the justification for a lower tax rate on capital gains relative to ordinary income is threefold: it is not indexed for inflation, it is a double tax, and it encourages present consumption over future consumption.” Rogers also pointed out that lower tax rates on capital gains increased investment and raises more tax revenue than higher tax rates.

President Trump, while on the campaign trail, used carried interest as a way to deliver his populist message. He expressed concern that the lower tax rate was being abused by hedge funds and other Wall Street investment vehicles.

To thread the needle between protecting the economy and protecting from abuse, Rep. Brady is offering a proposal that would require investment managers to hold an investment three years to qualify for the capital gains tax rate through carried interest. Among those ecstatic by the idea is Steve Bannon, President Trump’s former advisor who is seen as one of the architects of the president’s America First proposals.

Bannon said, “I have long called for the elimination of the carried interest loophole but I believe that the proposal in the House tax bill requiring investments be held for a minimum of 3 years to qualify for capital gains is a good way of eliminating short-term financial engineering that benefits no one, while encouraging long-term investments that create good paying jobs,” he said.

Speaking to a reporter, Sen. Pat Toomey (R-PA) said he expects the Senate to also add provisions into law changing the treatment of carried interest. It would make perfect sense for leading conservatives in the Senate – John Thune (R-SD), Orrin Hatch (R-UT) and Chuck Grasssley (R-IA) to adopt Mr. Brady’s idea.

If Congress ultimately sends a tax reform bill to President Trump including provisions like those contained in the House legislation, it will lead to tax reform more conducive to creating economic growth and millions of new jobs for the American people.

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