
Close My Tax Loophole - jstreebin
http://www.nytimes.com/2016/08/27/opinion/close-my-tax-loophole.html
======
millstone
I have read that the differential tax treatment of income and capital gains
has given rise to various techniques for "transforming" ordinary income into
capital gains via "pass-through" entities [1]. This transformation is
apparently quite labor intensive while being wholly non-productive (save for
the favorable tax treatment).

I don't understand what these pass-through entities do at all - can someone
explain it?

Naively it seems like differential tax treatment creates distortionary
incentives. Maybe I quit being the sole proprietor of my business in order to
day trade, thereby escaping payroll and income taxes. This replaces productive
work with non-productive speculation - a loss for the economy and a country.
What's the argument against this?

[1] [https://tcf.org/content/commentary/10-reasons-to-
eliminate-t...](https://tcf.org/content/commentary/10-reasons-to-eliminate-
the-tax-break-for-capital-gains/)

~~~
mtanski
> Maybe I quit being the sole proprietor of my business in order to day trade,
> thereby escaping payroll and income taxes. [...] What's the argument against
> this?

The argument is that, it doesn't work like you think.

If you're day trading chances are you're generating short term gains (or
losses). Mist day traders don't hold positions 1yr+.

Second as a sole proprietor your still responsible for payroll taxes, or what
becomes known as self employment tax. [http://www.marketwatch.com/story/do-
you-owe-the-self-employm...](http://www.marketwatch.com/story/do-you-owe-the-
self-employment-tax-2013-08-20)

------
ageek123
[http://mobile.nytimes.com/2016/07/16/business/dealbook/the-c...](http://mobile.nytimes.com/2016/07/16/business/dealbook/the-
carried-interest-loophole-what-loophole.html) is a reasonable explanation of
why this isn't really a loophole.

~~~
rlucas
The Klinsky explanation you linked to is borderline disingenuous. Nah, it's
just disingenuous.

It's exhausting and daunting to list all the ways that Klinsky's ELI5 example
is meaningfully different from what really happens in PE-land.

What it comes down to is this: PE managers get a success fee for managing
other people's money without putting up their own, which is very very normal,
and usually counts as earned income (normal tax rate).

However, when certain very specific circumstances apply, a bit of the tax code
lets you legally pretend that instead of a success fee, the amount you get
paid is a return on invested capital.

Very plainly, the pension funds, sovereign wealth funds, HNWIs, etc. who put
up the actual risk capital into the PE funds are putting dollars at risk and
earning a return on invested capital.

If one simply does the exercise of asking, "where are the dollars that the PE
manager put at risk?" the lie is exposed.

My personal pet peeve on this is that, back in the 1970s, it was actually the
case that the general partners would have had unlimited liability and
therefore really were, after a fashion, putting the entirety of their capital
at risk to earn the carry. But since the 1990s at least and probably earlier,
everyone in this game has used a pass-through LLC blocker entity to limit the
personal liability of the managers. So they keep all the tax benefit but give
up that pesky "risk" part.

(Partnership structures and carried interest actually do have other things to
recommend them as ways of aligning interests and making deals work. But
pretending that the contingent, earned, success-based portion of income
accruing to the manager is a return on risk capital invested _for tax
purposes_ is just a total fiction.)

~~~
amluto
> However, when certain very specific circumstances apply, a bit of the tax
> code lets you legally pretend that instead of a success fee, the amount you
> get paid is a return on invested capital.

I'd love to see an explanation of why it makes any sense to continue treating
capital gains income (i.e. "return on invested capital") any differently than
ordinary income. If we fixed _that_ , then the carried interest "loophole"
would cease to be relevant because it wouldn't change the tax rates paid.

I don't see why the tax code should incentivize passive investment over actual
work.

~~~
Lazare
The economics of taxation are fairly well understood, and they make it clear
that not all taxes are equal. In particular, some taxes have higher
"deadweight losses" than others, which mean it is much less efficient and more
damaging to the economy and to society to rely on them for revenue generation.

And listing commonly discusses taxes from lowest to highest deadweight losses,
it goes: Land value tax, property taxes, consumption taxes, income taxes,
capital taxes.

> I don't see why the tax code should incentivize passive investment over
> actual work.

Because to do otherwise causes real harm to all of us, because while even a
large tax on, eg, land doesn't notably change the supply of land, a small tax
on investment income does reduce the supply of investment. And reduced
investment lowers productivity across the industry, reducing worker
compensation and making us all as a society poorer.

In short: You get less of what you tax. That makes taxing eg, CO2 production a
great idea (we want less of that!), and taxing investment a pretty bad one.

(More generally: The tax code is the worst possible way to do income
redistribution, and the American obsession with trying leads to really poor
outcomes. If you want to help the poor, _try giving them actual money_.
Regressive taxes funding a progressive welfare state works; the reverse does
not.)

~~~
semi-extrinsic
> The tax code is the worst possible way to do income redistribution, and the
> American obsession with trying leads to really poor outcomes.

Northern Europe would like to disagree, and to point out that Americans are
far from obsessed with this. Take Mitt Romney: in 2012 he disclosed paying 15%
taxes on his around $15 mill./year income. In a reasonable country he'd be
paying at least 35%!

Actual progressive taxation without loopholes, together with a properly
implemented public health service, ending the health insurance industry,
government-funded parental leave for the first year of a child's life, and
otherwise socially responsible policies (ending the prison industry that
disproportionally targets the poor and non-whites, ending the war on drugs
etc) is a great way of doing income redistribution and society improvements.

~~~
Lazare
> Northern Europe would like to disagree, and to point out that Americans are
> far from obsessed with this. Take Mitt Romney: in 2012 he disclosed paying
> 15% taxes on his around $15 mill./year income. In a reasonable country he'd
> be paying at least 35%!

The overwhelming majority of Northern European countries have a lower top
marginal tax rate than that that on dividends and capital gains. So apparently
Sweden, France, Germany, Finland, Norway, etc. aren't "reasonable countries"?

------
cheriot
Income from investment is taxed less than income from work in order to boost
the economy by incentivizing investment, right? (Please tell me if there's
another good reason.) Does our economy still need this? Interest rates are
low, long term rates are low, and there's enough money sloshing around hedge
and venture funds that people are worried about reckless "yield seeking"
behavior.

So why do we still incentivize investment more than work? Perhaps we don't
need transfer payments to offset wealth inequality, perhaps we just need to
stop giving the wealthy so many advantages.

~~~
todd8
Yes there are other reasons. I'm not sure if they are good reasons, but a
logical tax system would need considerable changes in lot's of areas.

Here are two of the reasons for a separate capital gains tax rate. First, when
you say sell a house or piece of property or really anything, some of the
difference in price is due to inflation or deflation. When I bought my first
house in 1980 the rate of inflation was around 14%. If I had sold a $100,000
house one year later for $114,000 I would have more dollars but each would be
worth less and I would in effect made nothing on the investment. It makes
sense to normalize the gain with respect to inflation over the holding period.
They don't do that and this has a large impact on investments of all types
held for many years. The lower capital gains rate helps, but doesn't erase the
fact that you are being taxed on nominal income not real, inflation adjusted
income.

A second reason is that an investment in a company (by say buying it's stock)
goes up and down in value. In theory (at least according to some people) the
stocks value should represent the net present value of the future dividend
stream from the company issued to the shareholder. Dividends are uncertain and
it isn't always clear that a company will ever get around to issuing
dividends, but that's the theory. Nevertheless, this is how shares of a stock
are tied to the value of the company.

The company itself is trying to make revenue. This revenue is split into three
parts: (1) salary and benefits to employees, (2) dividends issued to
shareholders or (3) retained for future spending, improvements in the
company's machines (etc.) and cost reductions (driven by competition) to its
products. The profits are taxed at the corporate tax rate, the dividends are
taxed, and the salaries to employees are taxed. Thus, there are already taxes
holding back the "value" of the company to shareholders. Indirectly, before
shareholders see a gain in a stock's price, taxes are already being taken out
of company profits somewhere.

For these two reasons, it doesn't make sense to tax capital gains at the same
rate as ordinary income.

I know that this explanation might engender all kinds of fairness arguments,
but please, dear reader, understand that I'm not saying this this fair. I'm
only trying to point out some of the convoluted reasons that are used to
justify our current tax system. I would love to see the tax system completely
overhauled.

~~~
cheriot
Thanks, that's a great description. I'd forgotten about the second and never
heard of the first.

------
jgalt212
Obama, as a Democratic president, should be embarrassed and ashamed that he
has not closed this loophole. Treasury has the power to unilaterally do so,
but yet America's regressive tax policies with all there undesirable
consequences to exists.

Misallocation of economic resources towards tax-effective financial activities
over other more productive, but less tax-effective, activities.

Increasing wealth disparity in this country--so much so that the Fed is
basically afraid to raise rates because it would lower asset prices.

------
AznHisoka
There's no such thing as a tax loophole. It's either legal or not. If it's
legal and you don't like it then make it illegal.

You still get punished if you're a day less than legal drinking age and get
caught. So you can't have it both ways.

If they're not following the law then punish them.

~~~
rlucas
No, that's simply untrue when it comes to taxes. Once you get to the level of
money sloshing around that you can afford to pay for legal and banking fees
and new corporate entity filings, a whole world of shenanigans opens up, which
are plainly not ok but would be impossible to exhaustively legislate.

For example, you can manufacture losses for yourself to offset profits. You
can instead of realizing some income, loan money to yourself and spend it and
enjoy it while never paying taxes on it. You can wrap up dubious transactions
in layers of opacity such that you end up legally deducting your expenses on
hookers and cocaine.

The set of primitives exposed by the tax code, quite legitimately in order to
meaningfully address the real underlying economics of modern business and
finance, are also by necessity sufficient to build arbitrary shenanigans.

In hacker terms, it's like trying to create a "safe sandbox" for executing
arbitrary user-specified code. Once you allow a few things, like say recursion
or system calls, there's just no way to keep it truly "safe."

Being able to set up notionally arms length entities which you effectively
control is the tax code equivalent of shelling out to the OS.

So, no, the existence of a sufficiently complex tax code guarantees loopholes
and unintended consequences.

See also, DAO.

------
aminok
The income tax is a grotesque violation of Human Rights and should be
abolished. Threatening to throw someone in prison for refusing to disclose
their income or hand over a share of the currency they receive in private
trade is antithetical to a free society.

~~~
koralatov
I can't tell if this is satire or not.

~~~
aminok
What part of it resembles satire? There's nothing funny about throwing someone
in prison.

~~~
Dylan16807
And there's nothing funny about underfunded critical community services.

~~~
aminok
Throwing people in prison for not funding something, even if it is critical,
is wrong..

~~~
pdkl95
Failure to pay income tax is not a crime punishable with prison time. If you
cannot pay, all the IRS will do is arrange for future payment through civil
methods (e.g. garnishing future wages, putting a lien on your house, etc). If
your poor, the IRS won't throw you in jail. However, if you have a reasonable
source of income, you will be asked to pay your share of the services you're
using[2].

Note that _tax evasion /fraud_[1] is illegal, which may be difficult to
distinguish in some cases.

[1] not to be confused with tax avoidance

[2] services like national security, various types of infrastructure,
verification and enforcement of safety regulations (e.g. no melamine in your
food). You may not like all of these services - I certainly disagree strongly
with some - but citizenship is not _à la carte_ [3]. If you don't like some
things your tax money is going to, I encourage you to participate in the
political process so your opinions are heard, or even run for office yourself.

[3]
[https://www.youtube.com/watch?v=zSQCH1qyIDo#t=219](https://www.youtube.com/watch?v=zSQCH1qyIDo#t=219)

~~~
aminok
Refusal to report your private income (surrender your financial privacy) is
punishable by prison.

>If your poor, the IRS won't throw you in jail. However, if you have a
reasonable source of income, you will be asked to pay your share of the
services you're using.

This is false. The government does not ask. The government demands and
punishes non-compliance with expropriation of private property and or prison.

~~~
pdkl95
> Refusal to report your private income (surrender your financial privacy) is
> punishable by prison.

Of course. You still have to file tax forms, and if you have the money you
have to pay it. The situation I'm referring to is how not having the money to
pay taxes is only a civil offense. Failure to file or filing fraudulently are,
of course, offenses that risk jail time.

> This is false.

I suspect you're conflating filing the tax paperwork (i.e. 1040 and related
forms) with the actual payment. These are separate requirements with different
potential punishments for non-compliance.

> The government does not ask.

Obviously.

~~~
aminok
>Failure to file or filing fraudulently are, of course, offenses that risk
jail time.

So the income tax is a grotesque violation of Human Rights and should be
abolished.

~~~
Dylan16807
I fail to see how it's a violation of human rights to make fraud illegal.

~~~
aminok
It's a human rights violation to demand someone give up their privacy and
disclose their income, and then to demand that they hand over a share of the
currency they receive in private trade.

To even categorise refusal to disclose one's personal income as "fraud" (which
is an entirely different behavior) is political language to rationalise this
human rights violation.

~~~
Dylan16807
I was only asking about actual fraud, not failure to file. I thought you were
calling both violations of human rights.

------
hyperliner
Why do some people always want the federal government to solve their problems?
It's simple. Donate the extra taxes you should be paying at
[http://fms.treas.gov/faq/moretopics_gifts.html](http://fms.treas.gov/faq/moretopics_gifts.html).

(Edit: Also, there are plenty of problems with the Federal Government size
already. Pick a local cause such as Education, Low Income Families, Veterans,
etc. and you will find plenty of non-governmental state or county-level groups
and organizations who can put your money to a great use. Simply do the math
that would leave you with the income you should have if the tax rate applied
to your carry, and donate the rest).

~~~
YuriNiyazov
I think you missed the point of the article. At the risk of explaining the
obvious: the "my" in "Close My Tax Loophole" doesn't refer to just the author;
it refers to all venture capitalists and money managers. The _author_ may very
well be donating the extra taxes, but he wants others in his profession to do
the same.

~~~
hyperliner
That point was not made. The author wants the government to solve the problem.
Not a single call to action to other VCs was made to solve the problem by
themselves. The author should create the "VC Group for Local Change" and pick
a few missions and hire a few people to address them, and stop asking the
Federal Government to solve all problems that there are simply by throwing
money over the fence to make themselves feel good. It's not like we have an
effective Federal Government.

