The release of former Massachusetts Governor Mitt Romney’s 2010 tax return today may only inflame the controversy over the tax code’s treatment of some of the nation’s richest individuals.
Romney, who made a fortune of as much as $250 million in the private-equity industry, paid an effective tax rate of 13.9 percent on income of $21.6 million in 2010, according to a tax return his campaign showed reporters last night and will release today. That compares with the 35 percent top marginal tax rate.
The Obama administration and congressional Democrats are seeking to benefit from debate over the so-called carried interest provision, which provides a relative handful of investment executives with preferential tax rates. President Barack Obama views the tax break as a “loophole” that is “just not fair,” White House Press Secretary Jay Carney said last week.
At issue is the U.S. tax code’s treatment of carried interest, or the share of profits that partners in private equity firms, hedge funds and real estate developments receive as the bulk of their compensation. That income is taxed at the 15 percent capital gains rate rather than at ordinary income rates of as much as 35 percent, although many tax specialists say it represents compensation for labor.
‘Once and for All’
Representative Sander Levin of Michigan, the top Democrat on the House Ways and Means Committee, said the influence of carried interest on Romney’s tax bill “further illustrates the need to address this issue once and for all.”
“Regardless of whether compensation is earned for managing investments of other people’s money or providing other types of services, it should be taxed at the same rates paid by everyone else in the U.S.,” he said in a statement today.
Levin said on Jan. 18 that he plans to reintroduce legislation that would tax carried interest at ordinary income rates.
The opening round of a renewed effort to tax such carried interest as ordinary income may come as soon as tonight’s State of the Union address, expected to revolve around a theme of “economic fairness.”
For Obama and congressional Democrats, the issue’s appeal is more symbolic than substantive. There is almost no chance that a divided Congress this year would raise the tax rates that apply to such income. The notion that some of the nation’s richest individuals pay tax rates that are lower than millions of typical Americans, however, dovetails with rising public concern about the gap between rich and poor.
A Pew Research Center poll earlier this month found that 66 percent of Americans saw a sharp conflict between rich and poor, up from 47 percent in 2009. The largest increase in such sentiments was among self-described independent voters.
“It’s the wrong policy to have,” Buffett told Bloomberg Television’s Betty Liu in an interview. Romney is “not going to pay more than the law requires, and I don’t fault him for that in the least. But I do fault a law that allows him and me earning enormous sums to pay overall federal taxes at a rate that’s about half what the average person in my office pays.”
Payroll Tax Cut
Representative Chris Van Hollen of Maryland, the senior Democrat on the House Budget Committee, said on Jan. 20 that the carried interest tax break should be eliminated and the resulting revenue used to fund the administration’s proposal to extend the payroll tax cut for workers.
“These are people who are not putting their own capital at risk,” Van Hollen said. “They’re not putting their own dollars in the mix. They’re getting a special deal that’s not available to other people in the economy.”
The Private Equity Growth Capital Council, an industry group, says carried interest is “fundamentally different in character” from regular wages. If such income were taxed at regular rates, private equity investment could decline by $7.7 billion to $27 billion a year, according to a 2010 council study.
Private equity firms, including Romney’s former firm Bain Capital, usually put up a thin slice of a buyout fund’s capital. For example, Bain invested just $3.5 million, or 0.1 percent, of the $3.5 billion Bain Capital Fund VIII (PEF1136), launched in 2004. The company is scheduled to receive 30 percent of the fund’s profits once investors get their initial capital back, according to copies of the fund’s financial statements obtained by Bloomberg News.
Private equity firms also receive a 2 percent management fee, which is taxed as ordinary income.
Seeking to change the tax treatment of carried interest has risks for the Democrats. Brian Gardner, senior vice president for Washington research at KBW Inc., said the party’s strategy could backfire.
“There are Democrats that are close to and supportive of private equity and venture capital -- Bay Area Democrats, Silicon Valley Democrats,” he said. “It’s more complicated than people appreciate.”
Senator Charles Schumer, a New York Democrat, also has been in the middle of the policy debate that pits his party’s message against the interests of some of his constituents. In 2007, Schumer opposed tax measures that singled out carried interest compensation at private equity firms or hedge funds.
In a later move that doomed legislation changing the tax treatment of carried interest, he backed a measure that would have affected a broader range of businesses including oil and gas, venture capital and real estate partnerships.
Representative Kevin Brady, a Texas Republican who sits on the Ways and Means Committee, called the Democratic focus on carried interest “a political gimmick” with “zero chance” of passage.
“Make no mistake: most of that provision doesn’t hit those giant hedge funds,” Brady said in an interview. “It’s traditional real estate partnerships that build our office buildings, shopping centers and movie theaters and industrial parks.”
Between 2007 and 2010, the Democratic-controlled House passed legislation that would tax some or all carried interest at ordinary rates. Treating carried interest as ordinary income would generate almost $31 billion in revenue over 10 years for the Treasury, according to a 2008 estimate by the congressional Joint Committee on Taxation.
Half of Carried Interest
A narrower proposal that was passed by the House in 2010 and would have initially taxed half of carried interest compensation as ordinary income was estimated to generate $17.7 billion over the period.
Though lawmakers have debated the tax treatment of carried interest for years, the attention on Romney’s tax bill could capture the public’s attention, said Richard Pomp, a professor at the University of Connecticut School of Law in Hartford.
“The issue has been kick-started,” he said. “People will understand it in a way they never understood it before.”
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