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In The Public Interest: A Tale of Two Tax Rates

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A few years back, Warren Buffett used himself as an example of the injustice of our tax code. Buffet "was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent," the Washington Post reported. And that's just the beginning of this tale.

Blink and you may have missed it, but ending "tax cuts for fund managers" made its way into the President's discussion of fiscal responsibility during the State of the Union Speech and has, once again, been included in his proposed budget. What he's referring to is one of the most egregious loopholes in the U.S. tax code - the one that allows hedge fund managers to qualify for only a 15 percent income tax rate.

To put the injustice in perspective, a single person qualifying for a 15 percent rate makes $8,375 - $34,000 per year. But top fund managers, who also pay a 15 percent rate, bring home at least $75 million per year in "down year" and as much at $570 million in a good year. Two types of workers, with an income spread of multiple millions, are taxed the same.

The House passed legislation to close this loophole last year as part of the annual tax extenders process, but the Senate has yet to act. And both Senators and lobbyists alike are predicting that the measure is dead on arrival in the Senate. The question is, why?

While millions of Americans lost their jobs, their savings, their retirement, their health care and their homes, why is Washington in the business of subsidizing the very people who bet on the market collapse? It's unfathomable that by simply mislabeling their income as "carried interest," taxing it at the rate of a capital gain, these mega-millionaires are taxed at a rate less than teachers, police officers and small business owners, for example.

Our friends at Citizens for Tax Justice effectively debunk (PDF) a number of the arguments to keep this tax giveaway in place, such as the alleged negative impact on people's pensions (when in truth these funds are not taxed). Some in Congress characterize closing the loophole as a "tax increase" - when in fact it is just treating these employees and employers like the rest of us. Similarly situated workers are taxed at a rate of 35 percent and have payroll taxes added on as well. Why does this group get a special tax rate of only 15 percent? Why the two tax rates?

That's what makes many in the reform community incredulous - the government singles out one profession for special treatment. In testimony before Congress (PDF), Office of Management and Budget Director Peter Orszag (also former Congressional Budget Office Director) recognized the bizarre way in which hedge fund and private equity managers are singled out. He stated that carried interest is a form of "performance-based compensation" that should be treated as income, as it is in many other industries. And he noted that, for example, fees paid to actors "based on movie revenue... are taxed as ordinary income."

The recent economic turmoil shed light on a lot of financial ugliness and irresponsibility. It taught us hard lessons, one of which was that fund managers can do well by betting on failure or "trading above the pain," as the New York Times reported back in March, when they noted that the, "25 top managers reaped a total of $11.6 billion in pay" in 2008. It's even uglier when firms bet against their own clients. Even for them, in the worst of times, it was the best of times.

A fair tax code is in the public interest, plain and simple. Closing this loophole will more fairly distribute the tax burden and keep working families and Main Street businesses from having to shoulder the burden shirked by hedge fund managers. Just as when people and businesses hide their money overseas, the tax burden is passed on to the rest of us.

Rep. David Camp (R-MI), the top Republican on the House Ways and Means Committee, had a peculiar rationale for the tax break. As reported at Bloomberg.com, he put it in the context of other corporate tax breaks: "I don't think we should have permanent tax increases on some groups to pay for temporary extensions of law that benefit somebody else." But it's fine to give a small group of taxpayers a permanent tax break at the expense of all other taxpayers?

While this issue is often drowned out by more enticing political theatrics and the term "carried interest" may sound like accounting jargon, it's simple tax fairness that's never been more salient. If the rest of the taxpayers don't call on Congress to end these unfair tax breaks, we'll all continue to subsidize some of the biggest players on Wall Street.