Carried Interest
A Bad Idea During A Recession
Finally, Senator Joe Manchin got what he wanted and rolled over. At least, that’s what we are hearing. Hence, a new spending bill will make its way through Congress.
Increases in government spending are INflationary. They don’t take inflation down.
Government has input into the costs of goods and services but it doesn’t set the price. The “scorecard” I saw showed how all of this spending is revenue neutral. That’s always a joke.
Details are sketchy but supposedly:
15% minimum tax on corporations
Eliminating Carried Interest tax rates on Investment
First, raising taxes during a recession is not a good idea. Second, the way to spur GDP growth is to decrease corporate taxes and taxes on investment.
Corporations do not pay taxes, they aggregate them. They pass them along to their customers. If they pay higher rates of tax, they don’t increase salaries for employees nor do they invest in property, plants, and equipment.
Interestingly, Democrats want Biden to stop sending refined oil products overseas to try and decrease gas prices in the US. You’d think that would work because it would increase the available indigenous supply. Except, there is not enough storage for those products so it would all be wasted.
This bill kills an incentive for any company to invest in storage facilities to make the Democratic scheme work.
One of the smart things Reagan did to kill the inflation beast was to cut taxes on investment. For those that don’t know, carried interest is the money that people receive when they successfully operate private equity, real estate, hedge, or venture fund. If you are a general partner at one of those funds and cover the costs of operating the fund, 20% of what’s left of the profits accrue to you.
There are various tax codes for different funds. But, you generally pay the long-term capital gains rate on gains. That’s a big incentive to invest.
Democrats just crushed the incentive.
Don’t believe the old line white guy Champagne Socialist venture capitalists that welcome the increased taxes. There will be a bunch of them that fall in line. They already made their money. Must be nice to look from the mountaintop and make proclamations you wouldn’t have liked back when you were starting out or building your fortune.
If you are a younger fund manager, you just got screwed.
Full disclosure, I actively invested out of a fund from 2016-2021. If that fund is successful (and so far it has been very successful), I will benefit from receiving carried interest.
What incentive is there to start or invest in venture capital funds with this bill? It will kill investment in innovation. The cost of the risk vs the reward just went way up. In venture, at least 50% of these things fail and 40% make 1x-4x. You get paid on the one that is a moonshot.
Real estate funds and private equity funds invest in existing assets and make them more efficient. Its mission is to make what they invest in better. Sometimes they do it, and sometimes they fail. When they are successful, they get paid.
Economic incentives are aligned.
This bill penalizes risk takers and success. It will increase inflation, and hurt America.
The argument is that venture capitalists and private-equity partners who get paid off the ‘carry’ are really being paid for their labor, since it reflects the work done by the VC on behalf of the investors….and that hence, it should be taxed at ordinary income rates.
BUT…when people are taxed on ordinary income, that usually represents the compensation for labor they have performed in the current tax year and were paid for when it was performed, or shortly thereafter. Whereas the work a VC does on a deal is mostly front-end-loaded….he may spend a lot of time reviewing & filtering a range of possible deals, finally selecting a relative few of them, and then spend additional time structuring the deals. And the payback will very often be 5 years or more in the future. So he’s doing work that he won’t be compensated for for many years, if ever.
Rather different in timing from typical hourly or salaried work; looked at in that light, the carried-interest CG treatment seems reasonable.
From a business acquaintance, "Like Trump's tax bill before it, which was rushed through in reconciliation without a single Dem vote, this is a disaster of poor drafting, lack of clear policy and language bordering on the incomprehensible. The Democrats followed the lead of the OECD and put in a tax computes by reference to financial statement income. But unlike Europe where tax is computed by reference to financial statement income the US doesn’t do that and haven’t done it for 100 years. It will make money for the accounting firms but won’t grow the economy."