THE WRONG LOOPHOLE. Robert Reich makes a good case that Congress should close the tax loophole under which the compensation of partners in private equity firms is treated as capital gains (15 percent tax) rather than labor income. But the particular treatment of private-equity is not the loophole. It's the differential rate for capital gains in the first place that needs to be eliminated. Let's not get into these petty debates about what's a loophole. Let's just always remember to say: ALL INCOME SHOULD BE TREATED THE SAME, whether it comes from work or investment. And it has nothing to do with bashing the rich: If two people make $30,000, and one does it by working a double shift at Denny's, and the other does by sitting around the house collecting dividends from investments his grandfather made, shouldn't they at least pay the same tax? Or maybe the trust-fund slacker should even pay more, not less. You can't put it better than Warren Buffett, who notes that his secretary pays tax at a higher rate than he does. The private-equity loophole is really just one of many distortions in economic decision-making that are created when you treat different sources of income differently. Presumably the people who do private equity are right -- there will be less incentive to invest or work in private equity if it doesn't get the preferential tax treatment. But that just means that money was drawn into private equity not for reasons of economic efficiency, but for reasons of tax arbitrage. Get rid of the differential treatment, and you don't have any loopholes. I still don't understand why every discussion of taxes wouldn't begin and end with this point. It avoids all the tortured nonsense of the politicians who say they would repeal tax cuts but only for people above $200,000 -- oh, maybe $300,000. It's a simple, fair principle: treat all income alike. [UPDATE: I used a poor example here, I just realized. A single worker earning $30,000 would pay income taxes at a marginal rate of 15% anyway -- the same as the rate on capital gains. Only above $31,000 in taxable income does the rate go higher. A better example would be two people making $50,000. However, that's just referring to the income tax. A person with $30,000 in income from work would pay $4590 in payroll taxes (his own and the employers' share), whereas a person with solely investment income would pay nothing. So in addition to equalizing the income tax treatment of work and investment income, one could include investment income in the payroll tax base, along with raising the cap on the payroll tax, which in addition to fairness, would have the added benefit of saving Social Security.]
--Mark Schmitt
