10 Special Interest Tax Breaks That Cost You Plenty

#10: Taxing Wages Like Capital Gains

The government has to pay its bills. So every time someone else uses a loophole to pay less taxes, you pay more. 

That doesn’t mean every tax break is bad. Some benefit many people, like child tax credits or the mortgage interest deduction. Whether or not those policies are ideal, they have a straightforward policy justification. Not so for all parts of our tax code.

On the April business days leading up to Tax Day, I’ll take a look at ten tax code features that only serve powerful, narrow interests.  In honor of April’s Fool’s, here’s one that’s so wrong it’s hard to believe it’s true: the carried interest name game.

Renaming Wages Capital gains

Private equity partners and investment managers keep nearly 20 extra cents of every dollar they work for by mislabeling their income as capital gains. More precisely, the money is called their “carried interest”, but the point is it’s taxed at the low long-term capital gains rate instead of the higher ordinary income tax rates.

Since private equity partners and fund managers make tons of money this way, the missed tax dollars add up quick. The Congressional Budget Office calculated that this loophole will cost America $1.2 billion in just 2014. What could America buy with that money? Well, we could afford to repair or replace every deficient highway bridge in Kentucky, with about $100 million to spare.  Or Congress could divvy up the spoils nationally, investing in infrastructure and jobs in every state.

Capital gains are taxed at a much lower rate than ordinary income because America decided to reward people for putting their capital at risk. And that’s the problem: the fund managers didn’t put their capital at risk.

Instead, they agreed to be paid for managing the fund based (in large part) on the gain their work added to their investors’ capital. As conservative think tank American Enterprise Institute explains, the fund managers signed up for a performance bonus.  So why is it taxed as capital gains?

Campaign Contributions, That’s Why

The wrongness of this tax treatment is obvious to at least some Democrats and Republicans; both President Obama and House Ways and Means Committee chairman David Camp (R-MI) want to end it. Don’t hold your breath, though--reformers have been trying to end this loophole for years. Campaign contributors always stop the change. Indeed, Representative Camp’s proposal strikingly follows Wall Street’s decision to de-fund him.

So as you file your taxes on April 15, consider the lucky few who can donate enough to candidates to purchase the naming rights for their income. And pay much less tax as a result.