Democrats looking for payback in tax extenders

The Constitution has a prohibition against passing bills of attainder, but that doesn’t keep Congress from looking for some payback when it can get away with it.  The Wall Street Journal takes a look at the “tax extender” bill under consideration now and sees a desire for some class warfare that should have played itself out after last year’s AIG “rich hunt” blew up in Chris Dodd’s face.  With the economy staggering to its feet after more than two years, the bill declares war on the investor class and kills any incentive to take risks with capital:

In the 1999 movie “Payback,” Mel Gibson plays a small-time hood who ruthlessly takes on the mob to reclaim $70,000. At one point, he casually shoots holes in the luggage and suits of a high-living mobster played by James Coburn, who says, “Man, that’s just mean.”

That’s the attitude Democrats are taking to American capital markets, as they work to impose the most punitive tax rates on investment income in recent American history.  We’ve already reported that tax writers Sander Levin and Max Baucus plan to raise the tax rate on most “carried interest” income from 15% today to roughly 35% next year, and to about 38% in 2013. But it turns out that, like Mel Gibson, they also want to shoot holes in their victims’ suits.

In a little-understood provision, the Levin-Baucus bill would impose a new “enterprise value” tax on the sale of part or all of any investment firm that has ever earned even $1 of carried interest income. So instead of paying the capital gains tax rate on the sale of such shares, the owners would have to pay ordinary income tax on the proceeds of the sale. This means that owners in private equity firms or real-estate trusts would be taxed twice at a rate approaching 40%—first at the time the money is earned and again at the time of the asset sale. The combined tax rate would therefore rise well above 50%.

The Democratic justification for this punitive provision seems to be that firms like the Blackstone Group paid lower tax rates than they should have, so now it’s payback time. You’d think these firms have been doing something illegal, as opposed to paying tax rates under the 15% rate that Congress itself passed. But now in their scramble to pay for their runaway spending, Democrats want to punish people who played by Congress’s rules even if they earned only token amounts of carried interest.

Democrats have tried making the argument that equity-fund managers somehow got off the hook for paying income tax by realizing most of their compensation as capital gains.  Most of their income has been capital gains, though, and these fund managers paid the tax rate set by Congress on them.  They didn’t create a tax loophole or dodge the IRS (as some other notable Democrats have done), but followed the law.  These fund managers pay regular income tax on their management fees, and capital gains taxes on their “carry income,” which is the return on their own capital investment in the funds.

Members of Congress want to paint them as greedy fat cats who don’t pay their fair share, but we have always taxed capital gains at a lower rate for a reason.  Capital investment carries a lot more risk than earning a salary or hourly wage, or more to the point, earning interest income from savings and bonds.  We need people putting capital to use in order to keep our economy expanding by taking risks — but if the tax system treats income from risk the same as income from safer decisions, fewer people will take risks and the economy will not expand.

In fact, that’s what is happening now, thanks to signals like this tax expander bill that tell investors to keep their money on the sidelines.  Why take a risk that could lose capital if one has to pay the same rate on the uncertain return, when one can shelter the capital and pay the same rate?  The Obama administration is already hiking the capital gains tax to 20%, up from 15%, and now they’re looking for ways to eliminate the distinction altogether.

Democrats in Congress are desperate to do two things: find more money for their expensive nanny-state programs, and be seen as punishing capitalists.  Neither of these are good policy directions, and both will wind up strangling any recovery we have.

Fortunately, it looks as though the bill won’t get 60 votes in the Senate, because key Democrats are already expressing reservations.  Dick Durbin, for instance, is reportedly “seething” because the bill screws up a highway-funding formula that impacts Illinois, according to Congress Daily.  Evan Bayh, Ben Nelson, and Kent Conrad have “expressed concerns,” according to Congressional Quarterly.  Robert Menendez is flat-out opposed, according to the Huffington Post, worried that businesses will lose access to capital.  The tax-extenders bill looks like yet another overreach from the hard Left of the Democratic Party.