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Thursday, September 22, 2011

Carried Interest Tax Hikes: Anti-Small Business

Let's get something straight - you cannot be pro-entrepreneur, pro-small business or pro-job creation, and yet push for higher taxes on investment.

The biggest hurdle for most business owners to overcome is access to the credit and capital they need to get off the ground, invest, build and hire. Quite simply, increased taxes on capital mean reduced resources and incentives for investing in new and expanding enterprises.

Therefore, it's been very frustrating to hear President Obama mislead the public on the need to raise taxes on upper-income earners, including investors.

One of the President's favorite targets is the tax on carried interest. For decades, partnership tax law has recognized that carried interest - or ownership, profits-based returns for investment partnerships - is not ordinary income, like wages and salaries. Instead, carried interest is subject to all of the risks of ownership, directly tied to the enterprise value, and therefore, is treated, and correctly so, as capital gains for tax purposes, currently subject to a top rate of 15 percent.

The Obama plan eventually would increase the tax on carried interest by 189 percent, to a top rate of 43.4 percent as of 2013.

As a September 12 Bloomberg News report put it: "Obama ... wants to raise $18 billion by taxing the carried interest, or profits-based compensation, of private equity managers, real estate investors and venture capitalists as ordinary income, instead of more lightly taxed capital gains."

By the way, it's not just Republicans in Congress who are opposed to this idea. Some Democrats aren't too keen on this idea either. For example, as reported on September 12, "Reps. Jared Polis (D-Colo.) and Mike Quigley (D-Ill.) have argued that getting rid of the exemption would hurt the real estate market and other parts of the economy, not to mention stifle entrepreneurship."

Reps. Polis and Quigley are right on target.

As widely reported, nearly half of all partnerships in the U.S. are real estate businesses, and they rely heavily on carried interest. If serious about looking to get real estate back on its feet, isn't it counter-productive to impose higher taxes on those investing in real estate?

For good measure, private equity partners are not money managers. Instead, they are investors in firms, and active in the management process that spurs the firm on to increased profits, or, if the wrong decisions are made, to losses and perhaps failure. The risks are clear and substantial.

Finally, there's been a good deal of talk about making the U.S. tax code more competitive internationally. Unfortunately, jacking up tax rates on carried interest will make investing in the U.S. a far less appealing undertaking, especially compared to major competitors that do not tax carried interest at the higher tax rates that usually apply to ordinary income.

No matter how it is spun politically, raising taxes on carried interest is bad news for the entrepreneurs and small businesses that need capital to innovate, grow, build and create jobs.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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