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Congress is in a hurry, and when that happens we should all be nervous about the potential for unintended consequences from rash action.
In the next few weeks both an "Extenders" bill related to taxation and a Financial Regulation bill will be considered. Both bills have the potential for some serious policy miscues. But as it happens, where the two topics overlap, a veritable poster child of hastily designed bad policy is emerging.
The tax extenders bill has a number of popular short-term provisions which are being paid for with permanent tax increases. And now that the Congressional Budget Office has determined that the Financial Regulation bill raises the deficit, the push will be on to find even more ways to raise revenue.
One area of overlap that has been singled out for more taxes is carried interest, which represents the return on the investment that various investment partnerships receive if the projects they oversee prove successful. Frankly, there is a case to be made for raising taxes on carried interest by taxing it at regular tax rates. There is also a case for the current tax treatment of that type of income as capital gains.
Legislation that passed the House, but not yet approved by the Senate, would split the difference between these arguments by creating a blended rate that is 75% regular tax and 25% capital gains. That is the stuff of political compromise, which doesn't make a lot of policy sense and would create yet more complexity. It is part and parcel of how tax bills are written.
But the bill goes further than that in a way that causes serious harm to our tax system by broadening the reach of this new blended rate to things that bear no resemblance to carried interest. The provision under consideration makes absolutely no policy sense and seriously undermines some long standing principles of tax policy.
The only rationale for what is being done is political: to "get" private equity firms and those who invest in them. This is vigilante justice logic coming to tax policy, and walking down that road will create serious problems in the long term for our system of taxation.
What the bill does is tax all of the proceeds from the sale of an investment firm or partnership at ordinary rates if it ever received a single dollar of carried interest. Most investment partnerships diversify their investments into a wide variety of areas, so it would not be unusual for them to receive, or to have received, some income in this form. This proposed treatment violates two fundamental principles of sound tax policy.
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Ignore analyst's predictions, the best indicator of the general market is the price and volume action of the main indexes themselves.
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