During a recent interview, Senate Minority Leader Chuck Schumer (D-NY) laid out his ground rules for “working” with the Trump administration. The liberal New Yorker said he would only work with Trump if “he moves completely in our direction and abandons Republicans.” Naturally, the one place he wants to work with the incoming president is to raise taxes.
Schumer is a strong advocate of repealing the “carried interest” provisions of the tax code, a tax increase that would have devastating consequences to our economy. In technical terms, carried interest refers to the share of the investment gains earned by a professional investor in exchange for managing someone else’s money.
When an investment advisor makes money for a client, they get to keep a certain percentage of the profits that was agreed upon prior to consumating the deal. Under Internal Revenue Service rules, carried interest is treated as a capital gain and taxed as such.
During the late 1980s, a bipartisan consensus ruled that reducing the capital gains tax would be a boon to economic growth. And that’s exactly what happened. In 1981, the capital gains tax was cut from 28 to 20 percent. New economic activity created more federal capital gains tax revenues, which leapt from $29.4 billion in 1981 to $36.6 billion by 1983. In 1997, President Bill Clinton worked with Congress to cut the rate a second time. Sure enough, revenue increased again from $66.9 billion in 1996 to $114.7 billion by 1999, an increase of more than 71 percent.
Today, the Democratic Party is no longer Bill Clinton’s “Third Way” party. Now, raising taxes on capital is all the rage, and a carried interest tax increase is now the front-and-center of the Democratic agenda. It would be a huge mistake for the President-elect to abandon Republicans, as Mr. Schumer suggests, to increase taxes on what was once a bipartisan issue.
Investors must pay a capital gains tax when their stocks appreciate in value. But then when the investor cashes in, he or she must also pay a tax on the profit (via the income tax). Many in the Democrat Party now believes that profiting twice from a single transaction is great from a revenue standpoint, but Bill Clinton showed us that doing so actually reduces the number of government receipts received each year. Why? Because the double taxation results in the flight of capital from discouraged Americans.
The same holds true regarding carried interest. Andrew Quinlan of the Center for Freedom and Prosperity noted the fallacies of the left treating capital investment the same as labor income. “What they ignore,” he says, “is the unseen reduction in capital income that has already occurred due to corporate taxes, the fact that investments represent a risk as they are not guaranteed a return at all, and that such risk-taking needs to be encouraged to grow the economy.”
When someone partners with an investment advisor, both parties are taking a risk. The investor could lose their capital should the venture go bust, while the advisor could potentially never get paid. Both are investing an equal amount of resources ― the advisor puts in the cash, while the investor puts in all of the sweat and labor. Taxing the advisor the capital gains rate but the investor at the much higher income tax rate is not only morally wrong, but it is also ironically the wrong thing to do from a revenue and growth standpoint. Historically, it has resulted in more people dodging their taxes and less money going to the federal government.
While President-elect Trump has some faults, his entrepreneurial instincts are a great strength. He has made billions and lost some at the same time. Trump should understand that Schumer is setting up a trap to advance his progressive agenda. Hopefully, more traditional, Bill Clinton-like Democrats will understand this too and work with him to kill this destructive idea.