One of the best things that President George W. Bush accomplished in his eight years in office was a reduction in the capital gains tax. The capital gains tax had become a drag on investment, which discouraged people from putting their idle money to good use.
Bush’s reduction in capital gains wasn’t just a cut, but effectively a genuine improvement in how we tax. The changes became incentives, which mobilized dormant or idle capital. More money was made available in the economy in the form of long-term investments. In short, it brought productive and willing capital for growth.
Even with the Obama Administration and the Democratic Congress’s aggressive high tax and redistributive policies, they did not push rates back to the pre-Bush reductions. Openly, the left was afraid that aggressive tax hikes would backfire and negatively impact the anemic growth experienced during the last administration.
Reasonable Democrats and Republicans readily admit that it doesn’t make sense to tax capital gains like we do incomes. Fiscal and tax policy experts understand idle money should be invested or it will sit on the sidelines. With the right type of incentives, idle capital will continue to be deployed for growth. Putting money to work puts people to work.
Even considering the contrasting data between the pre-Bush tax policies and the Bush capital gains reform, there are some who are either close to or within the Trump Administration and Congress that are seriously considering doing away with the carried interest tax rate. Abandoning the carried interest tax rate would have profoundly negative implications and would slow long-term investment in our nation’s growth.
According to a misleading Bloomberg News article, the only benefactors to carried interest tax rates are “private-equity managers, venture capitalists, hedge fund managers and certain real estate investors.” The truth is, far more people would be affected. Americans for Tax Reform President Grover Norquist reminds us that eliminating the current carried interest set-up “would also hurt pension funds, charities, and colleges that depend on these investment partnerships as part of their savings goals.”
Many managers of investment funds do not draw a salary. Instead, they take their compensation from the fund’s fees and profits. If profits are achieved by means of long-held assets, in which performance has zero guarantee that profits will be accomplished, then capital gains tax is the appropriate way to tax managers.
Some might suggest that this is unfair or they argue that their income is earned and should share the same higher tax rate. Others that understand the world of finance and expansion economics recognize the enormous income risks associated with the “profit” model. Consider the following two points to help clarify types of income.
First, this money or profit earned is not a salary. The income is not guaranteed, nor is it often paid every month or every two weeks. Managers’ gains are based on performance. If their funds lose money, they suffer — and may potentially find themselves without a job. In some cases, the manager loses their job without a single paycheck. It is important to consider: if managers are willing to shoulder this type of income risk, shouldn’t there be incentives in place for finding successful returns on the investments they manage?
Keep in mind this type of incentive places the managers on the same side of the table as the consumers. If the investment goes up, everyone benefits. They are only compensated when the holdings profit.
Second, what’s being promoted publicly is only the tip of the camel’s nose. The whole reform is in jeopardy. Under the Obama administration, capital gains rates have already moved in the wrong direction. Doing away with carried interest rates would not only put downward pressure on fund managers, the changes would also include many small business owners who would feel the negative impact on their income from capital gains. Attempts to close carried interest would threaten their income and the growth of their organizations. Limited growth policies will also limit jobs, opportunity and prosperity for those dependent on the small business.
We need leaders, such as Senator John McCain and Senator Jeff Flake in my home state of Arizona, Senate Majority Leader Mitch McConnell, and public servants, such as President Trump’s Chief Economic Advisor Gary Cohn, to stand on the side of leaving tax policy unchanged as it relates to carried interest.
For some, closing carried interest appears to be a quick fix and helps to balance cells on the spreadsheet. For fiscal and tax experts, closing carried interest will limit economic expansion, reduce incentive for investments, damage the financial services industry, and threaten jobs within our nation.
Robert S. Graham is President and CEO of ROI Global Partners.