In his deficit reduction “vision”
speech on Wednesday, President Obama tried to distinguish his
plan from that of
House Budget Committee Chairman Paul Ryan by using a rather crude
analogy. The president said, “We have to use a scalpel and not a
machete to reduce the deficit.”
But when it comes to tax hikes — to extend the analogy —
the Obama administration’s 2012 budget is charging at business
partnerships of all sizes with what could be described as a
Texas-size guillotine.
The blunt instrument in Obama’s proposed fiscal year
budget unveiled
last February — a budget that he referenced on Wednesday as the
blueprint for his deficit plan — is a proposal to tax much of the
capital gains of a partnership as ordinary income as well as
subject them to hefty payroll taxes for Medicare and Social
Security. This would more than triple taxes in many cases from the
current top capital gains rate of 15 percent to the top personal
income tax rate of 35 percent. Or actually 39.6 percent, since
Obama would let the Bush tax rates expire too.
The contrast in Obama’s approaches to spending and taxes
could not be clearer. Obama insisted Wednesday that he would not
pursue spending cuts that “sacrifice the core investments we need
to grow and create jobs.” Whether the spending he wants to preserve
actually does “grow or create jobs” — and most of it does not —
is one thing.
But Obama shows no such care or precision when it comes to
making sure his tax policies do not “sacrifice the core
investments” of the private sector. The carried interest tax is a
direct attack on the structure of partnerships that are used by
innovative businesses — from small firms to venture capital and
“angel investor” groups — that take risks and make an outsized
contribution to economic growth and job creation.
Proponents of the “carried interest” want you to believe
that this will only hit big hedge funds. Not that there is anything
wrong with hedge funds per se, even though George Soros runs one.
As I
have written, they are one of the best forces to hold public
company CEOs accountable to all shareholders.
But the tax, as put forward in the Obama budget and by
legislation last year from the Democrat-controlled Congress, would
actually have a much broader reach to virtually all partnerships.
There is no asset or income threshold, so firms from venture
capital houses to doctors’ offices to family farms, all of which
are often structured as partnerships, could be negatively affected.
According to a new
study by the accounting firm Ernst & Young, “flow-through
businesses” such as partnerships and limited liability companies
“employ more than one-half of the private sector workforce in every
state except for Delaware and Hawaii.”
And a
report by the accounting firm KPMG on the Democrats’ “American
Jobs and Closing Tax Loopholes Act of 2010,” which passed the House
last year and came three votes short of the 60 needed to clear the
Senate, found that the bill “could apply to partnerships in
virtually any kind of business and could fundamentally change how
partnerships are taxed.”
In a partnership — from hedge funds to venture capital to
small business — the partners are taxed on a business’s earnings
at individual tax rates, instead of the business itself being taxed
at corporate rates and then doubly taxed on any dividends it pays
out. In many partnerships, some partners get bigger stakes in the
company because of the services they perform, in addition to the
capital they have contributed. This is called the “carried
interest.”
The individual with the “carried interest” is taxed at the
rates of ordinary income for his or her everyday salary and for
much of the business’s activities. But these partners pay the
individual capital gains rate when the other partners receive
capital gains for sales of such assets as stock and real estate.
The president’s budget would drastically change this, taxing these
gains as ordinary income and subjecting them to payroll taxes. This
would more than triple the rate of taxation in many
cases.
Even if there were an asset threshold for partnerships,
this tax hike should still be rejected because of its devastating
effects on the job creators. Although their investment strategies
differ, large venture capital partnerships are organizationally
structured in the same manner as hedge funds. According to the
National Venture Capital Association, “By more than
doubling the taxes paid by venture capitalists on carried interest,
Congress would be upending the risk/reward balance and creating
serious economic consequences for very little
revenue.”
Ironically, by stifling venture capital and innovative
partnerships, Obama’s carried interest tax hike would also be
cutting the lifeline of some of the very types of businesses he
champions, such as “green energy.” Folks peddling windmills and
biofuels are getting tons
of funding from venture capital and angel
investors, as well as arguably more deserving
entrepreneurs.
In short, Obama’s tax hikes on innovation and
entrepreneurship are a recipe for, to borrow his phrasing, losing
the future.
