

Why Taxing Carried Interest As Ordinary Income Is Good Policy - boucher
http://www.avc.com/a_vc/2010/05/why-taxing-carried-interest-as-ordinary-income-is-good-policy.html

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secretasiandan
The main points are

1) Carried interest is still a fee. It should not be tax advantaged. It should
be taxed like any other fee. This is actually a minor point, the author spends
1 paragraph out of 7 on this.

2) Financial services attracts more capable minds than it should because it
can pay better. Taxing it at a higher rate would "level the playing field"
encourage "more productive activities". 2a) Raising the tax will not reduce
investment because its not taxing the sources of capital more, just the
managers of capital more. 2b) Raising the tax will encourage managers to
invest more of their own money rather than others' money. This will encourage
better performance since they have more skin in the game

3) We need to balance the budget. This is a good source of revenue

I totally agree with point 1 with no qualifications. I don't disagree with
point 3 but I'd like to hear a good reason why this is one of the better
sources of revenue amongst all others.

I generally agree with point 2a, but don't really agree with point 2b. I agree
that having more skin in the game makes you more digiligent and cautious, but
the author fails to show that managers don't already have all/most/as much of
their money invested in their own fund as they can or the mechanism that
causes their risk tolerance to change such that they change their asset
allocation.

I have serious issues with point 2. Firstly, carried interest only applies to
funds/investments that qualify for long term capital gains treatment. I
generally disdain those areas because I think its more fluff than
science/business sense, but some areas like VC may require science/technology
oriented people who can see the possiblities in the business better than
someone who's just an MBA. But if you didn't have smart people deploying
capital to these risky technologies because they had a better understanding,
then these technologies would never get funded.

More fundamentally however, the author fails to qualify what makes one
endeavour more productive than another. Is google productive? They harvest
information and profit off of it. Does it make people more productive? Maybe,
but I have yet to see a study on the ratio of productive to non-productive
searches. In the end, google makes money because they're helping connect
buyers and sellers. Is marketing a productive activity?

If someone creates scientific breakthroughs in pharma/chemistry is it still
productive if the end use is to make cosmetics or cosmetic treatments for
people? Or what if its any technology that creates more free time for people
by automating some part of their life. Is it still a productive development if
all the people do with their free time is entertain themselves?

Full disclosure : I'm an ex-engineer who last worked at a quantitative hedge
fund. I think I'm doing more intersting things and potentially creating "more
societal benefit" by arbitraging "mispricings" in the market than I would
working in most companies/labs. This is partially because most companies/labs
are not doing anything that societally productive, so there's a low bar to
cross.

~~~
fexl
Ah, I'm glad some people are qualified to decide what to do with other
people's money -- it's all way over my head.

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pdx
If you feel that taxes are a valid way for a government to implement social
engineering, encouraging some behaviors and discouraging other behaviors, than
you can't ever complain about the complexity of the US tax code.

I would wager that a lot of people who nod their heads that this is a good
idea, also wax poetic at parties about how the tax code is broken and overly
complicated.

~~~
anigbrowl
I might well fit in that latter group, but I consider that the 'engineering'
in this case was on the part of the fund managers.

The managers have basically been surfing on the tax status of their investors'
gains. Funds of their own which were actually invested are still taxed at the
capital gains rate. But the managers' bonus can not seriously be called
capital gains, because it gets paid when they make a profit but they have no
corresponding liability to their investors if the fund should lose money. It's
not as if the investors were somehow lending a portion of their investment to
the manager, or s/he would owe repayment regardless of performance. Any
portion of the investors' gain paid as a bonus is income and deserves to be
taxed as such.

The lower tax rate on capital gains is meant as an incentive for people to
invest their assets instead of just hoarding them; investment implies an
element of risk.

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kgrin
Main point: while there's a good argument to be made for incentivizing people
to invest their capital, there's no good reason why one kind of money manager
(or, really, professional of any sort) should be taxed less than another. Just
because you work with money shouldn't entitle you to lower taxes, unless
you're actually investing your own.

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jrockway
The interesting point that this article brings up is that people are willing
to pay a few cents for each share of stock they are selling, but they aren't
willing to pay a few cents to send someone to Mars. If they were, then
engineering would pay as well as finance.

(A more practical example -- people aren't willing to pay a few dollars to get
to their destination faster. We paid engineers to make really cool airplanes
like the Concorde, but nobody was willing to pay the premium over conventional
1950s-era technology, so that's what we fly around in today. Money is the
answer to everything. The finance industry figured out what people are willing
to pay for and how much they're willing to pay, and that's what they charge.
Hence, we have ask/bid spreads, $50 overdraft fees, 22% interest rates, and so
on. It's apparently how people want to spend their money, and it makes finance
a profitable industry. The multi-trillion dollar bailouts are helpful, too.)

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dagw
People are willing to pay a few dollars to get to their destination faster.
For example I always take the direct highspeed trains over the slow train the
stops at every town, and happily pay the premium.

However with the concord it wasn't 'a few' dollars, it was close to an order
of magnitude over the cheapest tickets. It also really didn't get you there
that much faster, if you count your travel time from you leave your house
until you get to your hotel. For example to fly to New York I would have to
leave my house 2.5 hours (at the latest) before my flight, then spend 1.5
hours flying to the nearest airport with direct flights to New York, then
spend 3 hours waiting for that flight, then 7 hours on the flight to New York,
then 2 hours getting out of the airport and then I still have to get to my
hotel. So all that concord did for me was reduce a 14 hour trip to 10.5 hours,
and the place where it saved time was in the least annoying part of the trip.
Concord basically optimized away least painful part of the journey, and that
simply isn't worth paying that much money for. Now had someone found a way to
get me from my front door to my hotel in New York in say under 5 hours, then
all of a sudden I'm interested. Or if someone found a way in which I could
show up the airport 10 minutes before my flight leaves and get out of the
airport 15 minutes after arriving the gate (but making it significantly
cheaper than chartering a private jet), again I'd be very interested, no
matter how slow the actual flight was. So yes, people want to pay to get to
their destination faster, but concord-like airplanes aren't the solution to
that problem.

~~~
jrockway
The reality is that JFK-LHR and JFK-CDG were not really very long flights to
begin with. I'm not sure why the Concorde was used for those routings.

But for routings like ORD-HKG or JFK-NRT, I think a faster airplane would be a
good solution. These flights, when I've flown them (actually PVG-ORD and ORD-
NRT), have been completely full in first and business class -- and first class
is over $10,000 one way. I think people would be OK with a smaller seat if it
meant they were in the air for 6 hours instead of 13. 13 hours is a lot of
time to kill, even if you have a fully-flat bed and laptop power. (For me,
anyway. I can't sleep on planes at all, even in the good seats.)

I don't completely agree with your numbers about travel time to and from the
airport though. It takes me 45 minutes to take the subway from my house to
ORD, and then 30 minutes to get from check-in to the gate (10 minutes before
departure, of course). So that's 2 hours on one end. On the other end, it's
never taken me more than 2 hours to get from an airport to city center... even
in Tokyo (where the airport isn't even in the same prefecture as Tokyo).
London is particularly easy; immigration is pretty efficient, and the express
trains to Paddington are very fast.

Anyway, I think the Concorde discontinuation was due to "maximizing
shareholder value" rather than revenue issues. Concorde was considered the
"best" option between two cities that had Concorde service, but it was usually
less expensive than "real" first class. That is a lost revenue opportunity,
Concorde resulted in less profit per passenger-mile, and it cannibalized the
super-profitable high-end business.

(That's what's really holding society back -- shareholders.)

