Bonanza for the Super Rich: The Fund Managers' Tax Break

04/13/2015 09:16 pm ET | Updated Jun 13, 2015
Shutterstock / Gunnar Pippel

The reason most of us have seen little gain from economic growth over the last three decades is that the rich have rigged the rules to ensure that money flows upward. Through their control of trade policy, Federal Reserve Board policy, and other key levers of government, they have structured the market to weaken the bargaining power of ordinary workers and benefit the CEOs and Wall Street crew. As a result, the typical worker has seen almost none of the gains from economic growth over the last four decades.

Most of this rigging comes in before-tax income. The big gains to the rich have not been primarily because they have become better at avoiding taxes than they were four decades ago, but there are some notable exceptions. At the top of this list is the fund managers' tax break (a.k.a. the carried interest tax deduction). As tens of millions of people prepare to file their tax returns this week, it is a good opportunity to celebrate this tax deduction which gives billions of dollars every year to some of the richest people in the country for no reason whatsoever.

Many issues in tax law are complicated; the fund managers' tax break is not. It's just a good old-fashioned rip-off of ordinary taxpayers for the benefit of the wealthy. The basic point is very simple. The fund managers' tax break allows managers of hedge funds, private equity funds, and various other investment funds to have much of their pay taxed at the capital gains tax rate rather than the tax rate applied to wage income.

At present, this will typically mean a savings of almost 20 percentage points since the capital gains tax rate for the rich is 20 percent, compared to a 39.6 percent tax rate on ordinary wage income. The people who benefit from this tax break include some of the richest people in the country. Typically these fund managers earn paychecks that run well into the millions. Earnings in the tens of millions annually, or even hundreds of millions are not uncommon. (Think of Mitt Romney. He was one of the beneficiaries of the fund managers' tax break.)

The fund managers' tax break is real money for the people affected. In the case of a fund manager looking at $100 million in carried interest income, the tax break will mean an additional $20 million in their pockets. To put this in perspective, this is equal to 150,000 months of food stamps for the typical beneficiary.

The rationale for giving the super rich a lower tax rate on this money is that they are paid based on what they earn for their clients. Typically, the "carried interest" is equal to 20 percent of the earnings of a fund over some threshold. In other words, the fund managers are paid partly on a commission.

In this way fund managers don't differ from millions of other workers in the economy. Realtors, car salespeople, even clerks in clothing stores or shoe stores typically get much of their pay on commission. The difference between these workers and the super rich who run hedge funds and private equity funds is that ordinary workers have to pay the same tax rate on their earnings regardless of whether they are paid a straight salary or whether they earned it as a commission. It is only the fund managers who get to have their earnings taxed at a lower rate because they earned them on a commission.

There has been considerable discussion in the last year over inequality. Some have argued that increase in inequality over the last three decades is an inevitable part of capitalism, or at least that this inequality has been necessary to sustain the growth that benefits everyone.

It is difficult to see anything inevitable about the fund managers' tax break. Surely it is possible to envision a less corrupt Congress that doesn't make up tax rules exclusively to benefit the very rich. It is also difficult to see how the economy benefits from creating tax loopholes that cause people to spend their time gaming the tax code rather than doing productive work.

If presidential candidates and other political figures are serious about addressing inequality, it would be difficult to envision a better place to start than eliminating the fund managers' tax break. There are serious policy questions around many other measures to reduce inequality. On the fund managers' tax break there are none.

It's really pretty simple: handing taxpayers' money to some of the richest people in the country increases inequality.

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