Hedge fund managers generally make their money by charging their clients two fees. First, the manager receives a management fee, typically equal to 2 percent of the assets invested. Second, the manager typically receives 20 percent of the income from those investments above a certain level. This 20-percent share of the investment returns from hedge funds is known as "carried interest.'' Under current law, most hedge fund managers claim that this carried interest qualifies as a long-term capital gain, currently subject to a maximum tax rate of 15 percent, rather than being taxed as ordinary income, currently subject to a maximum tax rate of 35 percent.
But a moment's analysis shows that this money is ordinary income by any fair definition and should be treated that way. The 20-percent fee is not capital gains, because it applies not to capital that the hedge fund manager has invested, but to the payment he receives for investing capital that other people provide. Pretending that the 20-percent fee is capital gains when, in fact, it is payment for a service is an `"Alice in Wonderland'' argument that elevates fiction over fact.
(for full text of Sen Levin's comments, click here.)
Once again we see an attempt to twist capitalist theory to support a class of wealthy people who neither need nor deserve this support -- they are getting a tax break simply for doing their jobs. For example, take a plumber or carpenter who takes some work on spec: he works on a project for a "retainer" or the price of materials, and if it is successful, he gets paid the rest of the commission. Should payment then be given the capital-gains "discount" simply because he risked the commission on the successful completion of the job -- something that would be expected in any case? In fact, doesn't any worker risk her salary by performing work which, should it be shoddy, would result in her being fired?
And, of course, there is also the question of why the payoff is such a high percentage? If the investor makes $1 billion dollars, the hedge fund manager stands to make $200 million! It is only because the possible reward is so absurdly high that the risk of not getting it seems so dire. How much is that per hour of actual work? Does anyone deserve that kind of money (not to mention a preferred tax treatment as well)? Michael Milken, the purveyor of junk bonds, made this kind of money for years -- until he was thrown into prison.
It is this kind of gross favoritism of big money managers that has made the message of the "Occupy" demonstrators so compelling to so many people.
This series of blogs on tax fairness in not an attack on all wealthy people. It is hard to blame an investor for taking advantage of the tax breaks that are available. However, actually paying lobbyists and influence peddlers to get congressmen to vote for them is, in my opinion, antisocial behavior, as is the soliciting and acceptance of favors from these people unethical behavior on the part of senators and representatives.
As one of the readers of this blog (Anonymous) has pointed out, not all wealthy people enjoy the kind of tax breaks that Mitt Romney, for one, gets. He pays only about 15% of his huge income (almost all capital gains) in taxes, while, recently, the wealthy (top 1/10 %) have averaged close to 30%. You can read some of the breakdown in this article (forwarded to me by Anonymous). This is up from the average rate of less than a decade ago simply because, as happens in most recessions, capital gains income has been severely reduced for members of the investing (and coupon-clipping) class. Don't shed any tears for them: unless tax policy changes, the growing surge in the stock and bond markets will have many of them riding high again, taxwise, before long. Also, as this article mentions, the percentage of all taxes paid by the upper class is higher than for those in the bottom 50% or so. This doesn't make them virtuous, simply very highly paid in comparison with the lower brackets. Also, this percentage that they pay is down from pre-Recession times -- also because recessions hurt many rich people as well as the non-rich (though usually not as seriously).