The "Carried Interest" Loophole Is a Shame

Nick Kristof writes about the carried interest tax loophole in today's The New York Times. The loophole allows earnings taken from the profits of securities and financial transactions to be taxed at the capital gains tax rate (15%) rather than the normal marginal income rate (35% in the top bracket). The loophole mostly benefits those who work in high level positions in hedge funds and private equity firms who are take a commission directly from the profits of the transactions they manage. Kristof writes:

This tax loophole is also intellectually vacuous. The performance fee is a return on the manager’s labor, not his or her capital, so there’s no reason to give it preferential capital gains treatment.

Exactly. The fund managers work on commissions, and it is preposterous to tax those commissions differently than other performance-contingent income. A fund manager's commission's should be taxed no differently than a salesman's.

I oppose high taxes, but I am equally opposed to unfair and arbitrary taxes. Picking and choosing this or that type of income to be taxed at a preferential or discriminatory rate skews economic incentives and produces inefficiencies in the labor market that are ultimately disadvantageous to everyone. Republicans have been thoroughly in the right as they have criticized the Obama administration for pursuing policies that "pick winners and losers" rather than permitting normal market forces to shape economic outcomes. Its abdication of free market principles and a commitment to tax fairness in opposition to all "tax increases" is indefensible. (Also, it forces me to agree with Kristof, which I really hate.)

Republicans leaders have been wise to use the debt-ceiling negotiations to force spending cuts. They should further magnify their accomplishment by bargaining for a simplified tax code that would lower marginal income tax rates across the board in exchange for eliminating many of the various deductions, credits, and loopholes that imbalance economic incentives and impose substantial compliance costs on ordinary Americans. Tax simplification would increase the fairness of the federal revenue system, put money into the pockets of ordinary Americans, reduce the substantial compliance costs of paying taxes, and generally make the world a better place.