Editorial Board

Romney Should Showcase Leadership and End Carried Interest: View

Mitt Romney shouldn’t apologize for being successful. Nor, for that matter, should any American. On this we agree with the founder of private-equity firm Bain Capital LLC and Republican presidential candidate.

That doesn’t mean there isn’t a valuable discussion to be had about whether he and others owe some of their success to distortions in the tax code that tilt the playing field and need leveling.

Romney has already brought that discussion to the fore by disclosing that he pays an effective tax rate of about 15 percent, largely on income from Bain. The release of two years of his tax returns today will add kindling to the debate, as will this evening’s State of the Union address by President Barack Obama, who is expected to call for a more equitable tax code.

At issue for Romney is the ability of private-equity executives -- and managers of real-estate, oil-and-gas, venture-capital and other partnerships -- to classify their compensation as carried interest, which is their share of investment returns.

Medicare Exemption

Carried interest is taxed at the low capital-gains rate of 15 percent, rather than at ordinary income rates, which are as high as 35 percent. In addition, because it qualifies as a capital gain, carried interest is exempt from the 2.9 percent self-employment tax that funds Medicare, meaning that beneficiaries receive as much as a 22.9 percentage-point tax advantage over the vast majority of American wage earners, according to a . Ending the tax break for people who manage money could generate more than $10 billion in revenue over 10 years.

The private-equity industry argues unconvincingly that the capital-gains rate is appropriate for managers such as Romney because they put their own money at risk. Opponents of the carried-interest tax break point out, correctly, that private-equity managers are eligible for that low rate on profit just for managing other people’s money, regardless of whether they themselves have any skin in the game. It’s worth noting that workers in other financial sectors -- investment bankers and portfolio managers -- pay ordinary rates on their income, even though they perform essentially the same service for their clients.

Warren Buffett, an outspoken opponent of carried interest (along with Mayor Michael R. Bloomberg of New York, the founder and majority owner of Bloomberg News parent Bloomberg LP, and Rupert Murdoch, chairman of News Corp.), told Bloomberg TV yesterday that he doesn’t fault Romney for paying no more than the law requires, and called on Congress to fix the inequity. “He makes his money the same way I make my money,” , “by moving around big bucks, not by straining his back or going to work and cleaning toilets or whatever it may be. He makes it shoving around money.”

Americans don’t begrudge people doing well; they do, however, begrudge unfair rules. Congress would do well to overhaul a tax code that values the work of people who shove around money more than the labor of janitors. Lawmakers have tried to redress this imbalance at least four times since 2007. All these efforts ended in failure, most recently last year, when Obama included a proposal to eliminate the loophole as a way to help pay for his jobs bill. Not coincidentally, private-equity executives have been big contributors of campaign funds to lawmakers of both parties, as well as to Obama and now to Romney.

It is good news, then, that some in Congress are determined to try again to do away with what amounts to a taxpayer subsidy for a handful of people, who, by all accounts, are doing quite well. Representative Sander Levin, the top Democrat on the tax-writing House Ways and Means Committee, announced he would introduce a bill in coming weeks. Levin’s proposal will probably be a slightly recast version of one that has previously passed the House as part of broader measures, only to be stripped out of final legislation in the Senate.

Simple Fix

Uncharacteristically for tax legislation, it’s quite simple: Executives of investment services partnerships will be eligible for the capital-gains rate only on profit they can demonstrate was accrued from a capital investment they themselves made. Their share of the profit they make for investors will be taxed as ordinary income.

There probably will be hue and cry that the change could discourage investment. It’s difficult to see how this would be so: The tax increase would affect only the managers of these partnerships, not their investors, who would still be taxed at the lower rate on the capital they put in.

We agree with Buffett that Romney has done nothing wrong in claiming the 15 percent tax rate. But Romney, by using this opportunity to call for the end of the carried-interest loophole, could in one swoop neutralize an issue that has hampered his campaign and display the leadership he says he would bring to the White House. In an election year dominated by the twin issues of the deficit and income inequality, this proposal is one both parties, and their candidates, should embrace.