Taxing those private equity billionaires (and their little dogs, too)

" As is so often the case, I'm not at all sure. You got any good ideas?"

yeah, tax capital gains as regular income, because the lower tax rates encourages people to take risks they would not otherwise take. Its like going to the casino -- only gamble what you can afford to lose, and if you win, you get taxed like its regular income.

You want to put capital formation on a par with casino gambling? If low gains rates increase the potential upside on high-risk and low-risk investment alike, just how much distortion occurs? Assuming you don't want all that big money to go into time deposits, that is.

More specifically, though, proper treatment of hedge manager profits requires tweaking the code to reflect a new(ish) business and investment practice. Managers' profits interests are most closely comparable to interests for services, and should be treated as service income. Note that the arguments from proponents of the current treatment largely are based in policy, not law.

More taxes are not going to solve anything. That's for sure.

"You want to put capital formation on a par with casino gambling? If low gains rates increase the potential upside on high-risk and low-risk investment alike, just how much distortion occurs? Assuming you don't want all that big money to go into time deposits, that is."

no distortion occurs -- that is the whole point. The distortion occurs when you start treating some kind of income different from other kinds of income. Its the status quo that is a distortion -- making all income taxed the same reduces the distortion.

"More specifically, though, proper treatment of hedge manager profits requires tweaking the code to reflect a new(ish) business and investment practice. Managers' profits interests are most closely comparable to interests for services, and should be treated as service income. Note that the arguments from proponents of the current treatment largely are based in policy, not law."

As long as you have different tax rates for different kinds of income, you will have people finding ways to work the system Just tax it all equally, and be done with it.

Why is simplicity supposed to be the paramount, exclusive virtue of a tax system? Tax is just another feature of the economic landscape. Like the other features, it isn't perfectly regular. Tax loads are imposed by one set of players just as other factors contributing to ultimate return are imposed by others, and the tax system is no less subject to feedback/market forces than those other return components. The impending fight over hedge managers' profits participations is an example of that feedback/market mechanism. This society can afford to have an occasional wrangle about how to tax some newish kind of receipt. People gaming the system and sometimes getting slapped down is the only real alternative to flat-earth statism.

By the way, my point questioning the true amount of distortion caused by gains rates noted that high and low risk investment generally is taxed the same way. You're talking about something different, taxing investment gain and earned income the same way. I guess you could think of it as a system that taxes all your uses of your time one way, and all your uses of your money in another.

Bravo, Paul and CS! My inclination is toward simplicity, because I resent that our tax code favors full employment for the legal and accounting professions, at the expense of more productive roles. But any changes should tread gingerly, because there is probably a relationship between how we tax various types of renumeration and our resulting behavior. Justin may recall that I made that same point in a previous posting.

"But any changes should tread gingerly, because there is probably a relationship between how we tax various types of renumeration and our resulting behavior. "

I think that changing behavior is the whole point. Right now, we give favorable treatment to high risk behavior --- not just in the tax code, but in preventing investors from losses in high risk ventures. The recent semi-meltdown at Bear-Stearns is an example.

Investors were "clamoring" for higher return investments, so B-S started a new hedge fund with $40 million of its own money, $600 million from "investors", and $6 billion in loans. In other words, B-S's exposure in this fund should have been no more than $40 million.... the rest of the risk should have been assumed by the investors and lenders.

But this hedge fund started sustaning losses, and these investors and bankers started freaking out. B-S had to bail out the fund to the tune of over $3 billion in loans -- and of course B-S's stock price dropped. Someone who had invested in "low-risk" B-S stock thinking that B-S's exposure in the high-risk hedge fund was only $40 million now had stock in a company whose exposure in the high risk hedge fund was $3 billion.

And here is the explanation for why B-S screwed its "low risk" stockholders....(from the NY Times)

'Bear Stearns is bailing one of the funds out because it is worried about the damage to its reputation if it stuck investors and lenders with big losses, said Dick Bove, an analyst with Punk Ziegel & Company.

“If they walked away from it, investors would have lost all their money and lenders would have lost all of the money,” Mr. Bove said. But “if they did that to everyone in the financial community, the financial community would have shut them down.” '

Now, there is no evidence that B-S was dishonest in its promotion of the high-risk hedge fund... investors and lenders KNEW what they were getting into, and should have been willing to accept the risk of high losses. But they aren't.... basically, they blackmailed B-S into protecting them from the consequences of their own greed -- at the expense of people who were interested in a "low risk" investment opportunity.