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New York | 02/17/2017
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It's Long Past Time to Close the Loophole

By Jeff Klein
Leo Hindery, Jr.

The tax code is complicated. It's dense, hard to understand, and sometimes seems pointlessly convoluted. For the most part when we encounter confusing rules or loopholes we know they exist for a legitimate reason. The carried interest loophole, to put it succinctly, does not fall into that category.

Carried interest gets its name from the medieval tradition of ship captains taking a "cut" of the profits from the sale of the cargo they carried. These captains risked their lives in treacherous and pirate-infested waters "carrying" goods to distant markets.

Fast forward several centuries, carried interest today refers to a tax loophole that allows investment managers' share of profits to be taxed at the capital gains rate, 15-20 percent, instead of as ordinary income, which at a maximum rate of 35 percent could more than double their federal tax bill. Yet these shares of profits are nothing more than negotiated risk-free management fees, and they should be taxed as such.

Today's beneficiaries of carried interest may think they're following in the tradition of the ship captains of old, but they are far removed from taking any personal risk since they're not putting any of their own money on the line.

We are firm believers in the merit of rewarding investors who provide investment capital. Our economic system only functions because people are willing to take risks and invest in enterprises, and taxing their capital gains at a responsible lower rate than ordinary income is a reasonable and fair method of encouraging such activity.

But there is no rationale at all for taxing any portion of the management fees which investment managers receive as capital gains, especially again because these managers are not at risk like the actual investors. Any gains or profits earned on invested money of their own should of course also be taxed as capital gains, but absolutely not the no-risk management fees which they earn, in whatever form.

Only a few thousand elite investment managers in the whole of the country benefit from carried interest taxation, and roughly a third of them live and work in New York state. These millionaire managers, some making tens and even hundreds of millions of dollars a year, pay a much lower tax rate than every other manager of a business or enterprise in New York. This at a time when our state desperately needs higher tax revenues for infrastructure, better schools, and other necessities.

There is no defensible reason why a few hundred investment managers in our state, who earn in the aggregate $3 to $4 billion a year, should have a combined state and federal tax of only about 29 percent.

Unfortunately, closing the carried-interest tax loophole overall is a federal matter requiring action by Congress. Yet even though this much needed and much overdue "fix" to the tax code is supported by Democrats and Republicans alike, the immense lobbying power of the rule's supporters has left any attempts in Congress at reform "dead on arrival." Just since 2012 hedge funds and banks have spent over a billion dollars lobbying Congress, which means that those of us who've been waiting for Congress to act will probably be waiting a very long time more.

New York state can't on its own close the carried interest loophole for Congress, but while waiting it can advance a "fix" targeting those investment managers working and living in our state.

Responsible New York state lawmakers have recently proposed a law that would close the gap between what these investment managers should pay and what they do pay by introducing a 19 percent "carried interest fairness fee" on money managers currently exploiting the rule. This law would go into effect only if similar bills are adopted in New Jersey, Massachusetts and Connecticut, which is necessary in order to stop these managers from moving across adjacent state lines in order to keep paying unfairly low taxes.

Using conservative estimates, the proposed "carried interest fairness fee" would raise an estimated $3.5 billion per year for our state. That's $3.5 billion each year for affordable housing, jobs creation, healthcare improvements, better schools and much needed infrastructure. It very well could be $3.5 billion we need if we face federal cuts.

It's past time for more tax fairness in our country, and it's beyond past time for the demise of the grossly unfair carried interest tax rule.

In the New York State Senate, Majority Coalition Leader Jeff Klein represents the 34th Senate District which includes the Bronx and parts of Westchester. Leo Hindery Jr. is a member of Patriotic Millionaires, co-chair of the Task Force on Jobs Creation, founder of Jobs First 2012 and a member of the Council on Foreign Relations. An investor in media companies, he is the former CEO of AT&T Broadband and its predecessors, Tele-Communications, Inc. (TCI) and Liberty Media.

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