The Carried Interest Tax Debate (continued)

I was reviewing my Lijit stats just now. I wish I could link out to them so you can see them. I had the search term tag cloud up for a while but I felt a little foolish with a tag cloud that started out with pants, widgets suck, and widgets blow, so I took it down. Socialist VCs was also near the top. That one I wear proudly even though it’s not true. This post will reinforce the socialist VC tag.

The number one search term that brought people to this blog last week was "carried interest". I haven’t written much on the topic but apparently that doesn’t matter. The one blog post I did write on the carried interest tax debate is the number five link in Google. And thus the traffic.

I strongly believe that long term capital gains should be taxed differently than short term capital gains. And I also strongly believe that capital gains should be taxed differently than ordinary income. The counter argument is that the economic incentives to take risk with your capital should be enough and you don’t need additional tax incentives. I don’t buy that. Human nature being what it is, most people are going to want to be conservative with their capital. Taking a risk with your capital, particularly on new business initiatives (whether its a new restaurant in the neighborhood or a cure for cancer), is something we need to encourage. And many of the developed countries in the world agree. In some countries, capital gains are not taxed at all. I don’t think we need to take the economic incentives that far.

But, and this is a big but that will annoy most if not all of my colleagues in the VC and private equity businesses, if you are generating those gains with other people’s money (OPM), then that is a fee you are being paid and it should be taxed as ordinary income. I really don’t see how anyone can argue otherwise with a straight face.

If congress is successful in taxing carried interest as ordinary income, it will massively increase the amount of taxes I pay. So be it. Someone has to pay the taxes to keep our troops equipped, our borders secured, our schools modernized, and our children healthy. It might as well be me and my wife.

But the capital that we invest directly in the funds we manage should be treated the same as if we had made the investment directly. When I put the Gotham Gal and my personal capital at risk and keep it as risk for years (sometimes it’s longer than ten years), that should be treated very differently than ordinary income. It’s not ordinary income. It’s a capital gain. And as I stated earlier in this post, let’s not throw the baby out with the bathwater in the hunt for a more equitable tax code.

I am not the only VC blogger to come out on the side of change on this topic. Bill Burnham (no relation to my partner Brad) wrote a good post last month. He doesn’t go as far as I do on the subject, and his ideas are more evolutionary than revolutionary.

Here are some more links to posts on this topic

PE Hub – Jason Klein Opposed to any changes

Start Making Sense An economic analysis (great name for a blog too)

CarriedInterestTaxation.com Not such a great name for a blog but this one is written by lawyers and is about nothing but this issue. Worth adding to your feed reader if you are tracking the carried interest tax debate.