H.R. 2834 - Proposed Tax Increase?

Posted: Jul 19, 2007 12:01 AM
H.R. 2834 - Proposed Tax Increase?

Guess what? Prominent Democrats in Congress may soon pass a huge tax increase. This tax increase will affect all, not just Wall Street. Because what is proposed is almost unknown to the American people and unless you, the American people, learn about this tax increase and protest to high heaven, they will succeed.

The proposed tax increase is H.R. 2834, a bill to amend the Internal Revenue Code of 1986 to treat income received by partners for performing investment management services as ordinary income received for the performance of services. It sounds innocent, but the truth is that since Harry Hopkins pronounced the formula to tax and tax, spend and spend, and elect and elect, many Democrats have adopted this as their motto. I am afraid that far too many Republicans also have an insatiable appetite for over-spending.

Leading the charge against this new tax is the Chief Deputy Minority Whip Representative Eric Cantor (R-VA). Cantor is not opposing this tax to be partisan. He is doing so because it is consistent with his record since coming to Congress.

H.R. 2834 is sponsored by Rep. Sander M. Levin (D-MI) and would reclassify carried interest as ordinary income. That represents a 133% on so-called flow-through investment partnerships. Retirees and anyone on a pension would be especially hard hit by this approach. The proposal would tax carried interest at 35% instead of the capital gains rate of 15%. Pension funds are some of the biggest investors in flow-through investment partnerships. Raising taxes on the partners will hurt the investors.

This measure does the opposite of what good public policy should. Good public policy creates capital. It does not discourage one from taking risks. Carried interest represents the sweat equity which general partners put into the deal. It is, in fact, capital and should be treated as such, which means taxing it at capital gains rates.

The management fee is already taxed as ordinary income, the profit -interest, or carry, represents an investment in the partnership. The tax treatment of profit interest on so-called flow-through entities has been settled for decades.

While compensation of employees and independent contractors is typically fixed and payable regardless of the success of the business, a partner's distributive share of partnership income is subject to the entrepreneurial risks of the partnership's business. The partners are rewarded only if the partnership succeeds.

A manager gets nothing back for his profit interest unless investors get all of their money back plus the negotiated rate of return. Wage earners are not taking that kind of risk. The policy reasons for drawing a distinction between long-term capital gains, short-term capital gains and ordinary income are the same as for giving capital gains treatment for carried interest. Current taxation of carried interest encourages the pooling of capital, ideas and skills in a manner which promotes entrepreneurship and risk-taking. The issue is whether Congress wants to change capital formation and the incentives for long-term investment.

In 2005, the last year for which we have such information, 2.8 million businesses were organized as partnerships. The flexibility of partnerships plays a very important role in the success of our economy.

One example of how these partnerships benefit retirees occurred in the state of Washington. There, the state employee pension fund netted an average of $26,000 more by investing in private equity than it would have by investing in the Sand P 599.

This bill would discourage such investment. If Congress can raise taxes on flow-through partnerships, it may challenge the current treatment of capital gains next. Let us remember, the economy really took off when the capital gains tax was lowered to 15%.

The problem with this tax increase is that it is a stealth increase. Few people know about it. It is also complex. The immigration bill could be defeated because the public easily understood it. Few understand this tax increase, which will be done in the name of fairness.

It is simple. Call your Congressman and tell him to vote no on H.R. 2834. If the Congressional staffer wants to get into all sorts of details with you, tell him your pot roast is burning.