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Taxation of Carried Interest
- hn_throwaway_99 8y agoTaxation of carried interest as capital gains makes absolutely no sense - I can't think of a better example really to illustrate "one set of rules for the rich and another for everyone else.'
- MR4D 8y agoCarried interest is effectively the General Partners share of the dividend. Dividends are taxed at a lower rate than ordinary income, so this is as well. This is true whether you’re poor and own one share of a dividend paying stock, or you’re Ray Dalio. Here a pretty good breakdown of how it works and why it makes sense [0]. To be clear, I’m not saying you have to like it, but the rich have been getting richer since the beginning of time. I don’t expect that will ever change. It’s as true with humans as with animals like lions (albeit the measures are different, as lions have no care about dollars). [0] https://www.cnbc.com/2014/03/04/cnbc-explains-carried-interest.html https://www.cnbc.com/2014/03/04/cnbc-explains-carried-intere...
- hn_throwaway_99 8y agoYes, but as the parent article states, and even what is pointed out in your own link, while dividends are taxed at a lower rate, the manager is paid the lower rate on capital that is not his to begin with. That's the part that makes no sense to me. It is quite simply an incentive payment for his labor: it's income that investors pay him for his expertise, and as such should be taxed at income rates.
- harryh 8y agoYou & I start a company. I provide $100,000 in seed money but little actual work/time. You provide no seed money but a lot of work & time. We agree to split ownership of the company 50/50. 5 years go by. We sell the company for $1,000,000. You get $500,000, I get $500,000. Should I get to pay a lower tax rate than you?
- hn_throwaway_99 8y agoThen let hedge fund managers organize their funds as equity purchases from their investors. To use your analogy, if managers were deserving of 20% of the profits, then structure it as investors own 80% and managers own 20%. Of course, that would make many hedge funds a lot less attractive for many investors. Hedge fund managers want to have their cake and eat it too.
- harryh 8y agoThat is (more or less) what hedge fund managers do.
- hn_throwaway_99 8y agoI know they are organized as partnerships, but the managers don't really have any equity rights to the committed capital, only the profits. But I guess that's really no different than an investor with preference rights in a startup. In any case, thanks very much for your explanations, really helped me think about the issue in a different way.
- harryh 8y agoHappy to help out! In any case, as I stated elsewhere(1), I'm actually not sure what I believe on this topic. I can really see it both ways. 1. https://news.ycombinator.com/item?id=17276214 https://news.ycombinator.com/item?id=17276214
- freeone3000 8y agoNo. You shouldn't. The person doing the actual work should be paying it as tax on labor, and the person who put up the funds should be paying it as capital gains. And obviously, capital gains should be taxed at a rate greater than labor.
- harryh 8y agoThat is a fine point of view, but perhaps outside the scope of the topic under discussion.
- MR4D 8y agoI think harryh ‘s comment states everything I could but much more succinctly, so I’ll just second his statement.
- harryh 8y ago:)
- guelo 8y agoIf the point of lower capital gains tax rate is to incentivize risking capital then the carried interest loophole makes no sense because the noney manager isn't risking his capital. His "share of the dividend" is just another fee that should be taxed as any other income.
- MR4D 8y agoIf you want to discuss “fair”, I’d tend to agree with you. But taxing them while not screwing out all the other business structures that look just like this (see harryh’s example above) is damn near impossible. Which is why the exemption is in there. Figure that out and it might change. Until then, you risk screwing up all sorts of businesses that are not financial let alone hedge funds.
- deleted 8y ago[deleted]
- forapurpose 8y ago> the rich have been getting richer since the beginning of time That's not true and we must be careful not to accept an aristocracy (or oligarchy) as inevitable. That the wealthy will inevitably hold and consolidate power is counter to the history of democracy, a specific rejection of aristocracy, and a system which has worked the other way in country after country to great success economically and politically - great news and great hope for humanity in these times. The foundation of the U.S. is that all are created equal, and after that it's a land of opportunity where merit wins out, not inherited wealth and corruption. If by that you mean that rich have been getting richer relative to others, that's certainly not true. In the U.S. it's been true since the 1980s, but it fluctuates and in most other advanced economies the proportional difference (the disparity) is much less. If you mean that there is not downward social mobility for the rich, that's also not true. I don't have the numbers, but I've read about research that overall social mobility (up and down) is significantly less than it was before Reagan. There's also the old American family story: Rags to rags in 3 generations. More concretely, the U.S. used to have higher taxes on the high income, and more importantly, a (much higher?) estate tax: Inherited wealth is not merit, but effective aristocracy. That said, I don't know the inter-generational overall trends of wealthy families. (Or maybe the parent means something else.) EDIT: Some clarification + the last sentence
- extradego 8y agoThe idea of democracy as a “rejection of aristocracy” has been well discredited for centuries now. The topic of discussion here is not “social” but economic mobility. Let’s not mix them up so carelessly. Economic mobility is a measure of ability, or potential, not concrete events. To discuss “downward” economic mobility is to imagine wealth being forced upon these folk.
- MR4D 8y agoI’ll pick out one point that you seem to miss - when the US taxed the heck out of people with high incomes, you still had people like Howard Hughes, Warren Buffet, and John Paul Getty becoming even richer than they were before. So yes, the rich get richer, and high taxes do not stop that (but present the illusion that it stops ). I’ll gladly admit I’m wrong if you can disprove my three simple examples. Last I hexked, they were R I C H.
- Alex3917 8y ago> one set of rules for the rich and another for everyone else The rich (LPs) aren't the ones getting carry, it's the GPs who get carry.
- hn_throwaway_99 8y agoMany hedge fund managers are plenty rich, oftentimes orders of magnitude more than some of their clients.
- Alex3917 8y agoYeah and there is that one chef at Google who made $45M. But the average wealth manager has less money than the average founder, and the average founder is broke as shit.
- noobermin 8y agoThere are people much more broke than the average founder but they don't get wealth manager's or founder's standard of life.
- thesausageking 8y agoCounterpoint from Matt Ocko (DCVC): https://twitter.com/mattocko/status/1005367508910596096 https://twitter.com/mattocko/status/1005367508910596096 1/ TL; dr: “Having gotten immensely rich in part due to a tax break, I now solemnly opine that it should be denied to others... with no consequence to me...” This is “pulling up the rope ladder behavior” - here’s why: 2/ Fred’s stance screws over underrepresented VCs the most... They are most likely to have smaller funds that - when they win (& I hope they do) - they have big carry events. They are then disproportionately taxed vs old white dudes living on big fees w/ cunning tax structures; 3/ and, every dollar coerced by the state from emerging women & PoC VCs for largely noise-level financial impact (vs killing Prop 13) and only really for political posturing means less $ to anchor their next fund’s GP commit, putting them at a fundraising disadvantage; and... 4/ ...smaller funds mean smaller mgmt fee, fewer women and PoC hired by those funds, and less reward for everyone from the partners on down - where a carry centric bonus/win for an associate might be hugely meaningful for their family.
- pvg 8y agoThis isn't a tl;dr, you're pasting the entire contents of someone else's twitter thread into an HN discussion. That's confusing and generally not good since it's not your comment and that person is presumably not here to participate in the conversation.
- sincerely 8y agoThe first tweet in the linked thread begins with "TL; dr:", it's not a statement by the comment author
- harryh 8y agoI'm not sure why Ocko is bringing women & PoC into the debate when they remain a very small minority of VC GPs. The minority is even smaller when you weight by AUM (and likely future gains) vs just counting the number of people. The fact is that a change to how carried interest was taxes would, by far, mostly affect older white dudes. I'll for hearing a legitimate counterpoint but this one strikes me as a fairly cynical manipulation.
- harryh 8y agoFWIW, here is the simple counter argument: Alice & Bob form a partnership to invest some money. Between the two of them they invest $100. After 5 years they sell their investment for $200. As far as the government is concerned, that's a long term gain of $100 and should be taxed as such. How Alice & Bob decide to split the gains is between them and not a tax question. I don't necessarily buy this argument, but it's a valid way to look at things.
- Alex3917 8y ago> I don't necessarily buy this argument Why should risking time and risking money get taxed at different rates? I guess I don't understand the argument for why LPs should pay less taxes than GPs. Especially since entrepreneurs get to pay longterm capital gains on their stock, and the risk profile of being a founder is basically identical to the risk profile of being a GP.
- harryh 8y agoYes, your first sentence is an especially pithy way to boil down what I wrote. When I said that "I don't necessarily buy this argument", I didn't mean that I necessarily disagreed with it either. TBH, I remain uncertain. It's interesting that you compare founders/GPs/LPs without bringing up employees. They also risk their time and, in a majority of cases, will not receive preferential tax treatment.
- hippich 8y agoEmployees invest their time for immediate pay off (they get paid twice a month, monthly or something like that typically) So in essence, this is short-term capital gain which is taxed at the same level as regular income.
- harryh 8y agoI'm sorry, I was unclear. When speaking about employees, I was talking about startup employees who take a significant % of their compensation as risky stock options. My point was about this portion of their compensation.
- cromwellian 8y agoHow about we require people who manage large funds to have their own “skin in the game”, perhaps they’d do a better job for their clients.
- cft 8y agoThis is a law that powerful people made for themselves. This is my only hope for a favorable crypto tax treatment: if only enough rich people own these, then the tax regime will be palpable to develop it.
- forapurpose 8y agoWe can argue rules, technicalities and definitions, but here's the overriding one: Everyone needs to pull their weight, pay their share. Nobody is more important than anyone else. Pulling your weight means equal sacrifice. It might be hard to calculate the equal sacrifice of someone making $20,000 and someone making $20,000,000, but I can tell you that $1,000 (EDIT: or 20% of income) is a heck of a lot more sacrifice for the former than the latter. I'm sick of people complaining about pulling their weight or saying they are too important to do so. Should taxes (and other laws) now be contingent on the government's judgment of your importance? I suppose the unimportant poor should cover the share of these extra-important wealthy. Personally, I'm kind of proud to pay my taxes and contribute to the enterprise of my democracy.
- Swizec 8y ago> I'm sick of people complaining about pulling their weight or saying they are too important to do so The people complaining the most are those too well off for assistance and too poor to bear their responsibility comfortably. That portion of the population where it feels like you can pay health care/insurance/taxes or afford to go out to dinner one night a month instead of cooking. It’s not a fun place to be. I grew up like that. There was a lot of talk about assholes in power stealing from us to give to the lazy bums on welfare.
- forapurpose 8y agoI've heard that. In your experience, does that match the hypothesis that it's just a tactic of the right to divide voters - turn the working class against each other (on racial and rural-urban lines too)?
- Swizec 8y agoI think “the right” flames it up, but my family was very liberal, even socialist, yet still felt this way. When the taxman takes so much it feels he’s stealing from your children’s mouths you’re gonna complain. Fundamentally people in this situation, in my experience, don’t really care who is in power because they see them all as the same sort of enemy: the rich and powerful oppressing the working poor and pandering to the destitude so they look good and charitable on paper. This is hard to imagine if you’ve never been in a situation where a 5% discount on a gallon of milk is incentive enough to go to a different supermarket for this week’s grocery run.
- millstone 8y agoWhat is the modern argument for preferential tax treatment of capital gains? Arguments against it seem compelling to me: 1. The American dream is achievement through hard work. But taxation of capital gains privileges ownership over labor. That's just un-American. 2. This preferential taxation creates an anti-productive industry dedicated to re-casting ordinary income as capital gains, leading to misallocation of resources. 3. Many states including California tax capital gains at the same rate as ordinary income; CA is not exactly suffering from lack of investment income. 4. Optics are terrible: I and many other ordinary Americans pay a higher average tax rate than the very wealthy, including ex-presidential candidate Mitt Romney and in all likelihood President Trump.
- deleted 8y ago[deleted]
- harryh 8y agohttps://en.wikipedia.org/wiki/Optimal_capital_income_taxation https://en.wikipedia.org/wiki/Optimal_capital_income_taxatio... is a good place to start. Right up top is a nice summary: "Starting from the conceptualization of capital income as future consumption, the taxation of capital income corresponds to a differentiated consumption tax on present and future consumption. Consequently, a capital income tax results in the distortion of individuals' saving and consumption behavior as individuals substitute the more heavily taxed future consumption with current consumption." Here is a simplified explanation of the above: http://www.thebigquestions.com/2010/01/27/a-quick-economics-lesson/ http://www.thebigquestions.com/2010/01/27/a-quick-economics-...
- millstone 8y agoThese arguments use a simplified model where capital income occurs as the consequence of investing wage income. They don't address the modern reality that capital income replaces wage income, through accelerated depreciation, inheritance, carried interest, etc. And yes, of course taxing capital is distorionary; but so is taxing labor, and exponentially so when capital income may be substituted for labor.
- RyanShook 8y agoI get annoyed when smart, wealthy people say that tax laws need to change while at the same time take advantage of the tax break becuase it’s ‘the government’s job to fix.’ Either pay the additional amount you think is fair and complain about it or take the tax break and don’t. But please don’t complain about it while simultaneously benefitting from the that which you say is wrong.
- beat 8y agoThe correct solution to this problem is to abolish the distinction between capital gains and ordinary income (ie wages), and abolish the corporate income tax that justifies the "double taxation" argument that justifies the capital gains rate. Capital gains is why Mitt Romney can make 200 times as much as I do in a year, and pay half my effective tax rate. This is broad across the economy. It's a fundamentally immoral tax model. Moreover, it's a socially dangerous one - the idea that there is one set of rules for the rich and another for everyone else is already stressing our nation. Stop actually proving the point, lest you want a revolution to deal with it when society lacks the nerve. Corporate income tax is no big loss. For one thing, it's an increasingly shrinking part of our tax base. For another, it's riddled with loopholes and borderline graft, much more so than individual taxes. This kind of stuff is biased against entrepreneurship, in favor of cozy relationships with politicians. Being connected is more important than being hardworking or imaginative. Tax capital gains as ordinary income. It's simple and fair.
- kneath 8y agoCapital gains is wage theft. If you have money, you are taxed at a lower rate than people who have to earn it. Carried interest is just a follow-through of this principle that is apparent at every level of American government. Those with money steal from those who must earn it.
- tome 8y agoI guess the HN "Georgist land tax as a solution to all taxation problems" meme has died off.
- tardo99 8y agoHere's how I think it should work: You can get capital gains treatment on returns on investments in a given year which don't exceed 20% a year compounded annually. This would apply whether or not the taxpayer has realized the gain (though I'd be fine with an exception for startups to give them, say, 5 years to pay since liquidity events don't always align properly). This solves the situations that enrage people, namely: * Carried interest * People that luck into huge gains on flyer investments (i.e. bitcoin or whatever * Startup founders who get capital gains treatment because of the $100 (or whatever) that they put into the company initially In each of these cases, these are really speculations, not investments. There's nothing wrong with that, but I don't see why it should get preferential tax treatment.
- etaty 8y agoCapital gain tax or income gain tax are designed to make the wealthy wealthier. Don't tax "gain", tax the "wealth". This will make it harder and harder to hoard wealth as you gain wealth. Every other "tax" can then be removed. So with the "wealth" taxt, every year you sum all your possessions and you give X% (20%?) to the government. This look simple enough to me, did any country try that?
- wycs 8y ago20% wealth tax per year? Think about what you are saying. The state would own everything after 20 years.
- Applejinx 8y agoYeah, it would work great and incentivize all the right things, but you wouldn't need anywhere NEAR that. Given that this would apply to individuals and companies (all forms of abstraction and consolidation), have it be 1 (one) percent. Then if you're doing complicated finances to get all you can out of three different entities, you pay 3 percent wealth tax. And if you have basically nothing, you don't have any of these entities or holding companies so you pay just your personal one percent wealth tax. Getting the corporate shield from personal liability would be well worth double dipping the one percent.
- drblast 8y agoInflation is a wealth tax. It's not necessary for the government to ever tax anyone for anything; they could just print the money and all "taxes" would come in the form of inflation instead. And that tax would be simple and unavoidable. A very progressive tax system could be "print money and give it to everyone equally." If you're poor the guaranteed income would be a huge percentage of your wealth and since you have no savings the resulting inflation would affect you least. The wealthy with savings would essentially be taxed like you describe at the inflation rate. This is a thought experiment rather than a suggestion for a workable system, but I think like the "ideal op-amp" it might be useful to compare tax systems to this one.
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- tim333 8y agoThe carried interest exemption is shockingly unfair. I think the only reason hedge fund managers can pay 15% on a $100m income while say a nurse may pay 40% on a modest income is the fund managers are able to pay lobbyists to effectively bribe the politicians to let them pay less. It's only in the USA - I'm in the UK where we have a huge finance industry without this nonsense. It should go.
- lpolovets 8y ago(Disclosure: I'm a VC in California, which is one of the states proposing this tax.) For what it's worth, the tax rates being proposed on carried interest in these states are very high. E.g. California is proposing 17% while Maryland is proposing 19%. The result is that these carry taxes combined with a capital gains tax can be significantly higher than regular income taxes. I think imposing taxes of this size at the state level is foolish because I suspect many VCs would move to other states and commute. I already know LA VCs who fly to SF for 1-2 days every week, and the flight from Nevada or Portland would be approximately the same. Plus housing is much, much cheaper in those areas. It would be even easier to do this in Maryland, since Washington DC is so close.
- evgen 8y agoSounds like win-win. CA gets the parasites to move, then gets to declare that the policy works because CA companies still get investment, then the policy gets applied nationally. What's not to like?
- Dowwie 8y agoNew Jersey's new governor campaigned on multiple radical changes, including a "wealth tax". The governor is now trying to push this through Trenton. However, the Senate leader of NJ (Sweeney), although a Democrat, was recently reelected in what was one of the most expensive NJ Senate elections in history. Sweeney could not have succeeded at this game without the financial support of those who are most exposed to such a wealth tax. Naturally, Sweeney is sensitive to their tax exposure and has consequently opposed Murphy's plans. I don't see NJ taxing capital gains in an administration that has many other bold plans requiring party support.
- te_chris 8y agoThe real problem is that finance has got itself included inside the production barrier when really, a lot of what it does is charge outsize fees (e.g. vc and pe) and should really be considered rent-seeking.
- Pywarrior 8y agoIt sounds like the author does not want to pay taxes. How much tax does he want to pay?
- rdlecler1 8y agoTaxation of carried interest really made no sense to me. Sure, get the capital gains benefit off of your investment, but why should one get the capital gains for doing one’s job?
- mathattack 8y agoCourageous for a VC to say this.