Friday, October 12, 2007

I Hate Greed! (The Carried Interest)

That’s right, I hate greed. Don’t get me wrong, I do believe in the profit motive and free markets and all of that. I believe in profiting by providing a valuable service to members of society. I believe that if we all do that, whether through our labor, capital, or both, we as a society will prosper more than in any currently available alternative form of social organization. I do not, however, believe in finding creative ways to game the system to gain wealth at the expense of others. So can you believe in the profit motive and free markets, but still hate greed? Absolutely. And when people tell you that those two principals are in conflict, they are involved in something else I hate – spin.

You couldn’t escape the news today that the top 1% earners in the United States raked in a higher percentage of total earnings in 2005 than in previous years. As reported by The Wall Street Journal on Page A2 today, and here in the Online Edition:, the percentage that went to the top 1% is 21.2%. That’s right, the top 1% earned 21.2 % of all the income. According to the article, the data also suggest that many of the top earners are from Wall Street. Not surprising in light of the volume of mortgage backed security activity and private equity deals over the past few years. One tidbit that really stands out is that the top 25 hedge-fund managers earned more in 2004 than the chief executives of all the companies in the S&P 500 index combined. How much income do you need to get into the top 1%? In 2005 the bottom was $364,657.00 while the average was $1,591,711.00. I don’t know what the top was, but there had to be at least 8 figures if not 9 (before the decimal place). I didn’t make it to the top 1%, but that’s not why I’m angry. I do not begrudge anyone who makes a lot of money playing by the same set of rules that apply to everyone.

I am angry because of the fact that those top 25 hedge-fund managers walked away with a 15% tax rate on much of their income, while I paid a higher percentage of mine. Not only that, but all of those lousy mortgage loans they were packaging through the system are now the topic of various taxpayer bailout plans, so I will likely get stuck picking up some of the pieces they left behind while they were accumulating massive wealth.

Now, get ready for all of the statistical spin-babble you will hear over the next few days. For example “the top earners pay most of the taxes.” That’s true. In fact according to the IRS Statistics the top 1% paid 39.38% of all the income taxes, but earned (only) 21.2% of all the income. What was the tax rate? 23.13%. (That’s the lowest rate since 1986, which is as far back as the statistics go.)

OK, but if you were to insure a $10,000,000.00 property, wouldn’t you expect to pay more than someone insuring a $250,000.00 property? I certainly would (unless one of those companies I took private was a property insurer). Want the system to keep running so you can continue making so much money that you are among the most privileged souls to ever live? Then you have to be prepared to support that system that makes that possible, even if it means you will pay for more of it than those who get less out of it. Those who are doing all that other stuff like teaching, laboring, and so on, need to live too. Without them there aren’t any mortgages or student loans to package and sell. And what they make, after income taxes, payroll taxes (which applies to all of their income, not just the first month’s paycheck), property taxes, and sales tax (which is applied to almost all of their disposable income because they need to spend it all to live) doesn’t leave much extra to cover the tab. In fact, if you add up all of the taxes paid by the average earner and then take that as a percentage of their income, it’s a lot more taxes than the numbers suggest. On top of that remember that the average worker is also supposed to be saving for retirement because there isn’t enough money to pay for that (or health care) in “the system.”

My point is that we are all in this together and it’s only fair that we all play by the same set of rules. Those in the top income brackets pay more of the income tax because they can afford to, and without all of those “others” who can’t afford to pay it, the top earners wouldn’t be earning what they are. If I jump the income spectrum, I should have to pay the higher taxes (which I have had the displeasure of experiencing in the past).

Somehow, there are a privileged few who escape the rules of fair play and get more than they deserve. The system has been gamed. Those in power have managed to rig it in their favor. The “carried interest” rate of 15% is a sham against everyone, and those taking advantage of it, especially while we are at war, should feel a bit greasy. Of course, that’s just my opinion.

Update: For some background on carried interest (including some info in conflict with some of the above) go here:

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dd said...

Oh come on Mr. Palermo, If it's one thing I agree with Bush's tax policy it's the Capital Gains Tax Rate. I need some way to earn supplementary income, and therefore I turn to the options markets to make it. However, If we're going to be taxed at such high rates the market just wont function well (Taxed heavily on Gains, losses, just write off?)

But please specify how this would apply to the top earners, particularly Hedge Fund Managers. How is their compensation structured in a manner that let's them take advantage of the tax structure? I am under the impression that they receive straight cash bonuses - which is taxed at a high rate. (No stock options - Hedge Funds are private).

Anyway, based on your qualm it looks like you would be a proponent of the "flat tax" principle - one standard tax rate for all income. Suggest you look into voting for Ron Paul.

Palermo's Blog said...

Dear DD: Thanks for your comments. I am not at all against capital gains rates being low. The carried interest is not, however, a traditional capital gains tax. Money managers take a portion of the profits from others people's money they are managing (often 20%) as their compensation. They then "classify" that as capital gains rather than fee income. They claim the capital gain should pass through to them, even though it is not their money at risk. Capital gains treatment is meant to encourage investment, not to compensate managers. These managers have, however, figured out a way to gain from this tax treatment even though it was never meant to benefit people who did not put their money at risk. If this position is correct, then shouldn't real estate agents be able to claim their fee should get capital gains treatment through the capital gains of the homeowner? I like the low capital gains rate, even though the benefits accrue disproportionately to the high income earners (owners of capital). But the carried interest is, in my opinion (and I am not alone here) an abuse.