
Taxation of Carried Interest - tzhenghao
https://avc.com/2018/06/taxation-of-carried-interest/
======
beat
The correct solution to this problem is to abolish the distinction between
capital gains and ordinary income (ie wages), and abolish the corporate income
tax that justifies the "double taxation" argument that justifies the capital
gains rate.

Capital gains is why Mitt Romney can make 200 times as much as I do in a year,
and pay half my effective tax rate. This is broad across the economy. It's a
fundamentally immoral tax model. Moreover, it's a socially dangerous one - the
idea that there is one set of rules for the rich and another for everyone else
is already stressing our nation. Stop actually proving the point, lest you
want a revolution to deal with it when society lacks the nerve.

Corporate income tax is no big loss. For one thing, it's an increasingly
shrinking part of our tax base. For another, it's riddled with loopholes and
borderline graft, much more so than individual taxes. This kind of stuff is
biased against entrepreneurship, in favor of cozy relationships with
politicians. Being connected is more important than being hardworking or
imaginative.

Tax capital gains as ordinary income. It's simple and fair.

~~~
zimablue
Abolishing corporation tax has always seemed to me like something that makes
sense only in a quite naive view of the world.

The idea is always just to tax methods of getting income out of a corporation
instead, (income, dividends) but there's a problem with this idea.

There are infinite ways to get your money out of a corporation.

If you start off with: power is power all forms of power can be transferred
into money somehow

Then you realize that allowing someone to put their income into a company and
only pay tax on DIRECTLY taking it out, there's hundreds of ways to get around
that.

My company employs your son, then you give me a kickback in whatever form My
company buys from your company, you give me a kickback somehow My company
invests in something related to another investment that I hold and pushes the
value of it up. My company employs me on minimum wage for 80 years instead of
employing me on a high wage for 40 years, halving the tax that I pay through
income My company employs my own son, girlfriend, relative

If I have access to and control over an entity that can swing a million pounds
around you can guarantee I can find an indirect way to get paid from that
which you can't prevent/tax/foresee. The only reasonable way to mitigate that
is to slap some level of tax on me putting money into my proxy.

~~~
saalweachter
Not to mention, it assumes a priori that double taxation is _bad_.

Double taxation has _consequences_ , which may be bad or good in different
situations, but isn’t itself bad or good. Hell, I’m now getting double taxed,
through the adjustment to the SALT deductions.

------
millstone
What is the modern argument for preferential tax treatment of capital gains?

Arguments against it seem compelling to me:

1\. The American dream is achievement through hard work. But taxation of
capital gains privileges ownership over labor. That's just un-American.

2\. This preferential taxation creates an anti-productive industry dedicated
to re-casting ordinary income as capital gains, leading to misallocation of
resources.

3\. Many states including California tax capital gains at the same rate as
ordinary income; CA is not exactly suffering from lack of investment income.

4\. Optics are terrible: I and many other ordinary Americans pay a higher
average tax rate than the very wealthy, including ex-presidential candidate
Mitt Romney and in all likelihood President Trump.

~~~
WalterBright
1\. The higher the capital gains tax rate, the less money will be invested.

2\. Higher rates make for less efficient economics, because people will hold
on to poorly performing investments longer.

3\. A big chunk of capital gains are actually inflation.

~~~
millstone
Every point you make applies equally well to labor:

1\. The higher the labor tax rate, the fewer people will work.

2\. Higher labor tax rate makes for less efficient economics because workers
will prefer lower-paying (less stressful) jobs.

3\. Wage tax brackets are not indexed for inflation.

Given these, why should the tax code prefer capital ownership to labor?

~~~
WalterBright
1\. only if they have alternatives to work.

2\. are you sure about that? Lower paying jobs tend to be more stressful.

3\. they are last time I looked, though those things change over time

~~~
millstone
This sounds like the gross argument that it's more efficient to tax labor
because they have no recourse. The rich can move, hire lawyers, etc. to avoid
taxes, so more it's efficient to focus on the hapless poor!

The rebuttal is to simplify the tax code as to eliminate loopholes, such as
preferential income taxation.

You're right and I was mistaken that tax brackets are indexed for inflation.
I'd support indexing capital gains if it eliminated their preferential
taxation.

~~~
colechristensen
>1\. The higher the labor tax rate, the fewer people will work.

This is what you said and is basically untrue. It is not a gross argument, we
are talking about how taxation motivates people. The fact that wage income is
taxed does not seem like it would make people work less.

This may be different if we ever start a significant movement towards a post-
scarcity economy where automation makes necessities so inexpensive that people
with even a small amount of capital do not need to work. Then you might have
to do strange things to incentivize people to do the few jobs that need
humans.

------
hn_throwaway_99
Taxation of carried interest as capital gains makes absolutely no sense - I
can't think of a better example really to illustrate "one set of rules for the
rich and another for everyone else.'

~~~
MR4D
Carried interest is effectively the General Partners share of the dividend.
Dividends are taxed at a lower rate than ordinary income, so this is as well.
This is true whether you’re poor and own one share of a dividend paying stock,
or you’re Ray Dalio.

Here a pretty good breakdown of how it works and why it makes sense [0].

To be clear, I’m not saying you have to like it, but the rich have been
getting richer since the beginning of time. I don’t expect that will ever
change. It’s as true with humans as with animals like lions (albeit the
measures are different, as lions have no care about dollars).

[0] [https://www.cnbc.com/2014/03/04/cnbc-explains-carried-
intere...](https://www.cnbc.com/2014/03/04/cnbc-explains-carried-
interest.html)

~~~
hn_throwaway_99
Yes, but as the parent article states, and even what is pointed out in your
own link, while dividends are taxed at a lower rate, the manager is paid the
lower rate on capital _that is not his to begin with_. That's the part that
makes no sense to me. It is quite simply an incentive payment for his labor:
it's income that investors pay him for his expertise, and as such should be
taxed at income rates.

~~~
harryh
You & I start a company. I provide $100,000 in seed money but little actual
work/time. You provide no seed money but a lot of work & time. We agree to
split ownership of the company 50/50.

5 years go by.

We sell the company for $1,000,000. You get $500,000, I get $500,000.

Should I get to pay a lower tax rate than you?

~~~
thinkcontext
No, you have risked nothing but your time. Since you have no investment at
risk you should not get preferential tax treatment meant to encourage you to
do so.

~~~
harryh
(I think you might have inverted the "I" and "you" in my scenario making your
comment a bit confusing. But I think I understand the point you were intending
to make.)

Why is the risking of money deserving of special tax treatment but not the
risking of time?

~~~
thinkcontext
I personally don't think it is but that is the logic used to justify the
capital gains tax.

------
tome
I guess the HN "Georgist land tax as a solution to all taxation problems" meme
has died off.

------
harryh
FWIW, here is the simple counter argument:

Alice & Bob form a partnership to invest some money. Between the two of them
they invest $100. After 5 years they sell their investment for $200. As far as
the government is concerned, that's a long term gain of $100 and should be
taxed as such. How Alice & Bob decide to split the gains is between them and
not a tax question.

I don't necessarily buy this argument, but it's a valid way to look at things.

~~~
Alex3917
> I don't necessarily buy this argument

Why should risking time and risking money get taxed at different rates? I
guess I don't understand the argument for why LPs should pay less taxes than
GPs. Especially since entrepreneurs get to pay longterm capital gains on their
stock, and the risk profile of being a founder is basically identical to the
risk profile of being a GP.

~~~
harryh
Yes, your first sentence is an especially pithy way to boil down what I wrote.

When I said that "I don't necessarily buy this argument", I didn't mean that I
necessarily disagreed with it either. TBH, I remain uncertain.

It's interesting that you compare founders/GPs/LPs without bringing up
employees. They also risk their time and, in a majority of cases, will not
receive preferential tax treatment.

~~~
hippich
Employees invest their time for immediate pay off (they get paid twice a
month, monthly or something like that typically) So in essence, this is short-
term capital gain which is taxed at the same level as regular income.

~~~
harryh
I'm sorry, I was unclear.

When speaking about employees, I was talking about startup employees who take
a significant % of their compensation as risky stock options. My point was
about this portion of their compensation.

~~~
hippich
Aren't employees get a same long-term capital taxation treatment on profits
from their shares for their risk of taking part of the company in exchange for
their time?

~~~
harryh
It depends. But, in general, no.

Startup employees generally get equity in the form of stock options. In order
for employees to get preferential tax treatment on these options they have to
exercise these options at the time they are granted (which can require a large
outlay of cash) and then hold them for at least one year.

Due to the cost and risk of this exercise, most employees do not do this.
Instead they wait to see if the company becomes more valuable (and liquid) and
only exercise the options if so. At that point any realized gains are taxed as
ordinary wage income.

There are a great many resources online on this topic if you are interested in
more details.

~~~
hippich
sounds like a pretty bad deal... I am glad I never accepted stock options in
lieu of compensation.

EDIT: after reading more about it, it actually makes sense. What really
employee is getting is an "option" similar to one can buy for publicly traded
companies. And whatever option price is already reflected in employees tax
situation - it is an actual expense which lowers tax base by the cost of this
option.

Now - the cost of that option (i.e. different between full salary and limited
salary when getting options) is something that can be very incorrectly priced
(which I assume is the case in the majority of startups)

So it is not tax code discriminating against these employees. It is actually
employers taking advantage of these clueless employees.

~~~
harryh
From a strictly "expected value" calculation you are probably right that in
many cases startups are getting a pretty good deal when they get employees to
trade salary for stock options. It's hard to say if this qualifies as "taking
advantage of these clueless employees" though.

Certainly it is in some cases, but in others the employees could have a high
enough risk tolerance that it is a good deal for them.

In addition employees also often make career decisions on factors that are not
purely financial. This is also a perfectly reasonable thing for people to do.

~~~
hippich
From what I read typical stock option results in about 50k per year extra if
company succeed. Chances of hitting that are really really small. So
risk/reward doesn't seems to be right.

As for non-financial reasons - this is 100% valid point. But then why we are
talking about non-fair taxation? Stocks come into picture only when employee
exercise (at a nominal price on the moment employee was hired) The same would
apply if you use regular options for the publicly traded company on RobingHood
for example.

------
lpolovets
(Disclosure: I'm a VC in California, which is one of the states proposing this
tax.)

For what it's worth, the tax rates being proposed on carried interest in these
states are very high. E.g. California is proposing 17% while Maryland is
proposing 19%. The result is that these carry taxes combined with a capital
gains tax can be significantly _higher_ than regular income taxes. I think
imposing taxes of this size at the state level is foolish because I suspect
many VCs would move to other states and commute. I already know LA VCs who fly
to SF for 1-2 days every week, and the flight from Nevada or Portland would be
approximately the same. Plus housing is much, much cheaper in those areas. It
would be even easier to do this in Maryland, since Washington DC is so close.

~~~
evgen
Sounds like win-win. CA gets the parasites to move, then gets to declare that
the policy works because CA companies still get investment, then the policy
gets applied nationally. What's not to like?

------
Dowwie
New Jersey's new governor campaigned on multiple radical changes, including a
"wealth tax". The governor is now trying to push this through Trenton.
However, the Senate leader of NJ (Sweeney), although a Democrat, was recently
reelected in what was one of the most expensive NJ Senate elections in
history. Sweeney could not have succeeded at this game without the financial
support of those who are most exposed to such a wealth tax. Naturally, Sweeney
is sensitive to their tax exposure and has consequently opposed Murphy's
plans.

I don't see NJ taxing capital gains in an administration that has many other
bold plans requiring party support.

------
rdlecler1
Taxation of carried interest really made no sense to me. Sure, get the capital
gains benefit off of your investment, but why should one get the capital gains
for doing one’s job?

------
tardo99
Here's how I think it should work:

You can get capital gains treatment on returns on investments in a given year
which don't exceed 20% a year compounded annually. This would apply whether or
not the taxpayer has realized the gain (though I'd be fine with an exception
for startups to give them, say, 5 years to pay since liquidity events don't
always align properly).

This solves the situations that enrage people, namely:

* Carried interest

* People that luck into huge gains on flyer investments (i.e. bitcoin or whatever

* Startup founders who get capital gains treatment because of the $100 (or whatever) that they put into the company initially

In each of these cases, these are really speculations, not investments.
There's nothing wrong with that, but I don't see why it should get
preferential tax treatment.

------
cromwellian
How about we require people who manage large funds to have their own “skin in
the game”, perhaps they’d do a better job for their clients.

~~~
harryh
Most large funds do require that.

~~~
iseff
This is correct. The vast majority of funds have _at least_ 1% committed by
GPs. This is what Fred means when he writes, "The partners at USV make up a
sizeable portion of our funds."

------
te_chris
The real problem is that finance has got itself included inside the production
barrier when really, a lot of what it does is charge outsize fees (e.g. vc and
pe) and should really be considered rent-seeking.

------
forapurpose
We can argue rules, technicalities and definitions, but here's the overriding
one: Everyone needs to pull their weight, pay their share. Nobody is more
important than anyone else.

Pulling your weight means equal sacrifice. It might be hard to calculate the
equal sacrifice of someone making $20,000 and someone making $20,000,000, but
I can tell you that $1,000 (EDIT: or 20% of income) is a heck of a lot more
sacrifice for the former than the latter.

I'm sick of people complaining about pulling their weight or saying they are
too important to do so. Should taxes (and other laws) now be contingent on the
government's judgment of your importance? I suppose the unimportant poor
should cover the share of these extra-important wealthy.

Personally, I'm kind of proud to pay my taxes and contribute to the enterprise
of my democracy.

~~~
hippich
One potential problem I see with it - when welfare, public infrastructure,
country protection and other goods for all commons is outsourced to one
ambiguous entity (federal government) people who paid for it the most are not
getting respect for that, and instead are being called thieves and abusers of
the system and that they should give more. While praise (if any) goes towards
that ambiguous system.

When a large donor donates to some cause - they get their name out there. When
someone pays a lot of money into federal treasury - nil. It can be very
discouraging and further isolating from people actually receiving a direct
benefit (even if in the grand scheme of things everyone gets better off,
including these large taxpayers.)

Not saying there is a solution to that in modern states to that, but I can see
how paying taxes to ambiguous treasury not very fulfilling, and when one
actually cannot feel how they helped someone with it.

I have similar feelings when contributing to a large code base. Yeah, we get
top management's praise one a quarter/year about how good we did as a mass,
but I do not feel that. Perhaps if I could see how the code I contributed
somehow actually helped someone - I would feel better. But I could not come up
with some solution to that.

This I would imagine applies to many large systems. This includes so often
discussed BS jobs, which most likely are not, they are just perceived this way
because one who did it has no clue what effect their work had. And unless you
are "superstar coder", "industry disrupter", etc - no one even remembers your
name...

~~~
forapurpose
> people who paid for it the most

If we are talking about equal sacrifice, they did not pay the most, they paid
as much as anyone else.

> hen someone pays a lot of money into federal treasury - nil

Why should they get any praise for doing their share? Or everyone should get
praise (which I support). The premise that someone is somehow superior for
doing their fair share is fallacious. They are not aristocrats condescending
to help the poor; they are merely pulling their weight.

> are being called thieves and abusers of the system and that they should give
> more.

This is a strawman often used by advocates of low tax on the wealthy to, in a
standard rhetorical technique, somehow portray themselves as victims - which
is quite an incredible, cynical, and frankly embarrassing stretch.

In fact, consensus has supported decreasing taxes for the wealthy, which is
what has happened. Also, even those who oppose it, calling names is rare, IME.
I'm sure there are some out there, but given that it's just a portion of one
side of the debate, it's not many. If anyone on HN is using those words, I
don't recall it.

> While praise (if any) goes towards that ambiguous system.

I'm not sure what's ambiguous about it at all.

~~~
hippich
> If we are talking about equal sacrifice, they did not pay the most, they
> paid as much as anyone else.

I am talking in absolute numbers. There is plenty of research on who is paying
the most taxes. A just random result from google -
[http://www.pewresearch.org/fact-tank/2017/10/06/a-closer-
loo...](http://www.pewresearch.org/fact-tank/2017/10/06/a-closer-look-at-who-
does-and-doesnt-pay-u-s-income-tax/)

" A Pew Research Center analysis of IRS data from 2015, the most recent
available, shows that taxpayers with incomes of $200,000 or more paid well
over half (58.8%) of federal income taxes, though they accounted for only 4.5%
of all returns filed (6.8% of all taxable returns)."

~~~
noobermin
That's income taxes, the poor pay other taxes too. Also, the poor comprise the
people who cut your hair, clean your yards, make your food, essentially
provide for those making over 200K. Just because we don't provide the means to
live to them like we do for other people doesn't mean they aren't important
and don't equally sacrifice.

~~~
hippich
I am genuinely interested in seeing something about "total taxes paid"
(including sales tax, which hits the hardest low-income folks) but I could not
find such research.

And I am certainly not saying hair cutting is not important. For once, without
proper haircut CEO of the company will not be able to raise money to do a new
project which potentially can employ a lot of people and pay a lot of taxes.

------
mathattack
Courageous for a VC to say this.

------
Pywarrior
It sounds like the author does not want to pay taxes. How much tax does he
want to pay?

------
cft
This is a law that powerful people made for themselves. This is my only hope
for a favorable crypto tax treatment: if only enough rich people own these,
then the tax regime will be palpable to develop it.

------
thesausageking
Counterpoint from Matt Ocko (DCVC):

[https://twitter.com/mattocko/status/1005367508910596096](https://twitter.com/mattocko/status/1005367508910596096)

1/ TL; dr: “Having gotten immensely rich in part due to a tax break, I now
solemnly opine that it should be denied to others... with no consequence to
me...”

This is “pulling up the rope ladder behavior” - here’s why:

2/ Fred’s stance screws over underrepresented VCs the most...

They are most likely to have smaller funds that - when they win (& I hope they
do) - they have big carry events. They are then disproportionately taxed vs
old white dudes living on big fees w/ cunning tax structures;

3/ and, every dollar coerced by the state from emerging women & PoC VCs for
largely noise-level financial impact (vs killing Prop 13) and only really for
political posturing means less $ to anchor their next fund’s GP commit,
putting them at a fundraising disadvantage; and...

4/ ...smaller funds mean smaller mgmt fee, fewer women and PoC hired by those
funds, and less reward for everyone from the partners on down - where a carry
centric bonus/win for an associate might be hugely meaningful for their
family.

~~~
harryh
I'm not sure why Ocko is bringing women & PoC into the debate when they remain
a very small minority of VC GPs. The minority is even smaller when you weight
by AUM (and likely future gains) vs just counting the number of people.

The fact is that a change to how carried interest was taxes would, by far,
mostly affect older white dudes.

I'll for hearing a legitimate counterpoint but this one strikes me as a fairly
cynical manipulation.

~~~
klipt
> I'm not sure why Ocko is bringing women & PoC into the debate

It's this generation's "think of the children!" Just like Prop 13 was passed
via "think of grandma losing her house!"

------
etaty
Capital gain tax or income gain tax are designed to make the wealthy
wealthier. Don't tax "gain", tax the "wealth". This will make it harder and
harder to hoard wealth as you gain wealth. Every other "tax" can then be
removed.

So with the "wealth" taxt, every year you sum all your possessions and you
give X% (20%?) to the government.

This look simple enough to me, did any country try that?

~~~
drblast
Inflation is a wealth tax.

It's not necessary for the government to ever tax anyone for anything; they
could just print the money and all "taxes" would come in the form of inflation
instead. And that tax would be simple and unavoidable.

A very progressive tax system could be "print money and give it to everyone
equally." If you're poor the guaranteed income would be a huge percentage of
your wealth and since you have no savings the resulting inflation would affect
you least. The wealthy with savings would essentially be taxed like you
describe at the inflation rate.

This is a thought experiment rather than a suggestion for a workable system,
but I think like the "ideal op-amp" it might be useful to compare tax systems
to this one.

~~~
gghhzzgghhzz
not completely true that they could just print the money and demand no tax.
Without demanding tax payable in the government's currency then nobody would
have any reason to use that currency and the currency would have no value.

------
tim333
The carried interest exemption is shockingly unfair. I think the only reason
hedge fund managers can pay 15% on a $100m income while say a nurse may pay
40% on a modest income is the fund managers are able to pay lobbyists to
effectively bribe the politicians to let them pay less. It's only in the USA -
I'm in the UK where we have a huge finance industry without this nonsense. It
should go.

------
kneath
Capital gains is wage theft. If you have money, you are taxed at a lower rate
than people who have to earn it. Carried interest is just a follow-through of
this principle that is apparent at every level of American government. Those
with money steal from those who must earn it.

------
RyanShook
I get annoyed when smart, wealthy people say that tax laws need to change
while at the same time take advantage of the tax break becuase it’s ‘the
government’s job to fix.’

Either pay the additional amount you think is fair and complain about it or
take the tax break and don’t. But please don’t complain about it while
simultaneously benefitting from the that which you say is wrong.

~~~
savanaly
Couldn't disagree more. What's wrong with a prisoner in the prisoner's dilemma
playing the game rationally while also wishing he wasn't in a prisoner's
dilemma?

