As for which deductions and special breaks Romney would eliminate to offset the lower rates — well, he’s getting back to us on that.
Consider Romney’s position on one notorious tax break: the favorable treatment of “carried interest.” Mainly enjoyed by private equity and hedge fund managers, this break is a big reason Romney’s own tax bill was no more than about 14 percent of his multimillion-dollar income in recent years.
The carried-interest break not only accentuates income inequality but also overincentivizes the formation of investment partnerships, diverting capital — financial and human — from other, more productive uses. President Obama has sensibly proposed getting rid of it.
Given his background as founder of Bain Capital, Romney would have been the perfect Republican to join Obama’s call for carried-interest reform, in a Nixon-goes-to-China sort of way. Romney could even have turned the tables on the president’s party, noting that this loophole’s fiercest defender on Capitol Hill is the populistic Charles Schumer, Democrat of Wall Street — er, New York.
Instead, when Fortune magazine asked him about carried interest in a recent interview, Romney lamely replied that “if something is a capital gain, it should be treated as a capital gain. If something is ordinary income, it should be treated as ordinary income. I would look at each type of income, and I’m sure the IRS would do the same, to determine, is this really a capital gain or is it ordinary income?”
The former governor obfuscates out of self-interest — not personal but political. He dares not risk a rebellion by the Wall Streeters who flock to his fundraisers. Some of them can be remarkably self-righteous about carried interest, waxing eloquent about the risk-taking, job creation and freedom this arcane tax provision supposedly fosters. In 2010, billionaire Steve Schwartzman of Blackstone Group likened Obama’ s plan to end the carried-interest break to Hitler’s invasion of Poland. (He later apologized.)
And so in his Fortune interview Romney did not even attempt to claim credit for this surprising fact: Even though his tax plan does not target, and would not eliminate, the carried-interest break, it would significantly reduce the break’s value.
How? Typically, private equity, venture capital and hedge fund general partners collect 1 or 2 percent of the assets under management as an annual fee, which is taxed as ordinary income — top rate, 35 percent.
In addition to that, the general partners get 20 percent of the fund’s profits (above a minimum “hurdle rate”). This is the carried interest. If you think it sounds more like compensation for services rendered than a return on investment, I agree with you — especially since general partners rarely have much of their own money at risk.
But the IRS long ago embraced a different metaphysical perspective, which is why it’s treated as a capital gain.
And since the top capital gains rate is 15 percent — 20 percentage points less than the top rate on ordinary income — the characterization of carried interest as capital gains is very advantageous indeed. The cost of this loophole to the Treasury is about $1.5 billion per year, according to the Office of Management and Budget.
Romney’s plan, however, would reduce the top rate on ordinary income by a fifth, leaving it at 28 percent. The differential between the maximum ordinary and capital gains rates would decline as well, to 13 percentage points. This amounts to an implicit 35 percent cut in the value of treating carried interest as capital gains.
To be sure, there would be no impact on the deficit; revenue gained from closing the loophole would be lost to the lower ordinary-income rate. The disparate treatment of ordinary and investment income would remain embedded in the tax code. Other ways to exploit carried interest would not be affected.
But to the extent that Romney’s plan would alter perverse incentives that the current carried-interest break engenders, it would make both the tax code and the economy more efficient — at the expense of his financier supporters.
In short, Romney’s policy, though not nearly as definitive as Obama’s, is less retrograde than it might appear. Too bad the internal politics of his party prevent him from saying so.