Under current law, taxes as a proportion of the national economy
will rise sharply in the future, from just over 18 percent of GDP
today to a record-breaking 20.9 percent within 18 years and to
almost 24 percent before a newborn today reaches early middle age.
This scheduled rise threatens the growth of the U.S. economy and
the well-being of future generations.
Taxes need to be cut, not raised, and any purported tax reform
ideally should reduce taxes; at the very least, taxes should not be
Proposals now before Congress to "reform" the tax treatment of
private equity partnerships would substantially increase taxes.
Some estimates put the size of the increase at as much as $100
billion over 10 years for some versions of the legislation. This
tax hike would not only threaten the economy generally but would
also jeopardize a particularly important and crucial part of the
entrepreneurial economy: capital-intensive firms that take the risk
of investing in and restructuring underperforming enterprises and
putting them onto a sound footing. But bills by Senators Chuck
Grassley (R-IA) and Max Baucus (D-MT) in the Senate and
Representative Sander Levin (D-MI) in the House, and others in the
works, would change the tax treatment of these partnerships. One
bill would subject publicly traded private equity partnerships to
multiple taxation. Another seeks to tax "carried interest"
associated with these firms at high income tax levels rather than
at the capital gains rate.
The bills are bad tax policy as well as mere stalking horses for
an attempt to raise taxes by undermining the proper, lower tax rate
for capital gains. Moreover, to the extent that a theoretical case
can be made for taxing elements of carried interest as "labor
income" that should be taxed as regular income, three important
points must be considered.
First, income taxes should be limited to money
associated with day-to-day management services separate from money
associated with the risk-taking function of a partnership (or any
other business, for that matter).
Second, sound tax policy requires that the costs
associated with the management services should be made tax
deductible to the partners for tax purposes. The current
legislation does not address this side of the tax ledger-only the
side that would raise revenue. In fact, if the appropriate
deductions were included in any legislation, the result would
likely be a slight decline in total tax revenues, not the hike
foreseen by proponents of this "reform."
Third, under good tax policy, income is taxed only
once, not multiple times. It is fortunate that today the tax code
does not add corporate income tax to the other taxes paid by some
publicly traded partnerships. But the Baucus-Grassley legislation
would apply this additional level of taxation to many such
partnerships. Rather than further entrench bad tax policy, Congress
should be moving toward a sounder tax system by widening the
current, limited exemption from multiple taxation.
Despite the talk of reform and loophole closing, the aim of
these bills is clear: It is not to improve the tax code but to
raise taxes even faster than under current law.
Stuart M. Butler, Ph.D.,
is Vice President for Domestic and Economic Policy Studies at The