Cashing in on the Carry

The most controversial tax break on Wall Street, known simply as the Carry, is not authorized by any law and was never approved by Congress.

Instead, it grew quietly over several decades, hinted at but never directly addressed in obscure court cases and arcane regulations issued by the Internal Revenue Service.

Unchallenged by lawmakers, it swelled into a benefit that, by one back-of-the-envelope estimate, spares a small band of the country's richest and most powerful financiers $6 billion a year in personal income taxes.

Wall Street's Lucrative Tax Break Is Under Fire (Washington Post, 3 August 2007)

In a nutshell, here's how it works: fund managers and venture capitalists and those sort of folks arrange to receive much of their compensation as "carried interest," which is then taxed at capital gains rates (15%) instead of the twice-as-high (for their income bracket) personal income tax rates.

I agree with Judge Learned Hand on the subject of taxes: "Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."

Further, I think that low capital gains tax rates, which encourage investment, are a social good.

But the private-equity managers who are cashing in on the carried-interest loophole are, for the most part, not investing and managing their own money; they're performing services on the behalf of others. In other words, they're doing a job and being compensated for it.

As a society, we would do well to abolish the fiction that fees earned for managing hedge funds and performing other feats of financial engineering aren't "income" or shouldn't be taxable as such.