Donald Trump argues that Washington is captured by special interests, especially Wall Street.
Trump argues that Washington politicians don’t know how to make deals, including with each other.
Trump argues that a weak Republican establishment has let a Democratic president steamroll it with executive actions.
I have a humble suggestion for how the political establishment — particularly the Republican political establishment — can kill all three of these allegations with one stone.
Congress should close the “carried interest loophole.”
This refers to a quirk in the tax code that allows a small, mostly mega-rich segment of the population to pay much lower tax rates on the fruits of their labor than everyone else.
Managers at certain kinds of investment funds — such as private equity and venture capital funds — receive a share of the profits earned on their clients’ investments in exchange for the service of managing those investments. This performance fee is called “carried interest.”
Under current practices, these managers report this carried interest as long-term capital gains, which are taxed at 20 percent. That’s about half the tax rate these managers would pay if carried interest were treated as ordinary labor income and taxed at the top marginal rate.
Make no bones about it: This is a huge giveaway to a tiny but generally ultrawealthy and politically influential constituency. An estimated 60,000 households benefit from this loophole, according to Victor Fleischer, a University of San Diego law professor.
It’s a pretty niche tax issue, but the loophole is extremely unpopular among the masses and has gotten a lot of play lately on the political stage. Calls to close the loophole have been gathering steam at both the state and federal levels, and with Democrats and Republicans alike.
Hillary Clinton, Bernie Sanders, Jeb Bush and Trump all targeted this loophole for closure in their tax plans. Trump in particular has made it a frequent talking point, since it conveniently illustrates his sometimes-made populist claim that he’d soak the politically connected rich (even though his tax plan overall would dramatically reduce rates on high-income households).
“Rarely has a policy existed so long with such weak arguments in its favor,” former treasury secretary and former National Economic Council chair Lawrence Summers observed at a hedge fund conference this week, offering a backhanded compliment to the industry’s lobbying prowess. “It’s the First Amendment, the Second Amendment and carried interest, right?”
President Obama has advocated taxing carried interest as ordinary income for years, of course. And in recent months, a growing chorus of tax experts has argued that the White House can close the loophole without any action from Congress.
As Gretchen Morgenson explained in the New York Times last week, Obama potentially could instruct Treasury to change how carried interest is taxed through regulatory measures alone.
The administration thus far has shown little interest, at least publicly, in this route, instead insisting on the need for legislative action. “No one should be able to play by a different set of rules, so it’s time for Congress to act to close the carried interest loophole once and for all,” a Treasury spokeswoman told Morgenson.
But remember that administration officials had also initially pooh-poohed the legality and propriety of other executive actions ultimately taken by Obama after Congress failed to act, including on immigration and corporate tax inversions.
During the same conference panel that Summers participated in this week, Carlyle Group co-chief-executive David Rubenstein even seemed to tacitly acknowledge that the loophole could be closed through executive-branch action.
Should the Obama administration indeed decide to pursue closing the carried interest loophole through Treasury action, GOP legislators would find themselves in a very bad position.
Executive overreach is a touchstone of the Republicans’ anti-Obama narrative, so they’d be obligated to oppose such a move. Opposing such action, though, would play into the anti-establishment populist narrative — presented by Trump and Sanders, among others — that most GOP politicians are Wall Street puppets.
Which is exactly why it would be so smart for House Speaker Paul D. Ryan (Wis.) and the rest of the Republican Congress to get in front of this issue while it’s in the spotlight, and close the loophole themselves.
Relatively little money is at stake in the grand scheme of things (about $20 billion over the next decade, according to the Joint Committee on Taxation; Fleischer estimates it at about an order of magnitude higher). Nonetheless, plugging an unfair and unpopular loophole through legislative action would be a major symbolic victory. It would demonstrate that a Republican-led Congress could actually get something done, was not beholden to its financier donors and could even unify around the leadership of its new party standard-bearer.
Win-win-win — just the kind of dealmaking Trump has been advertising.