Talkin’ Revenues and Loopholes

February 5th, 2013 at 9:41 pm

My CBPP colleague Chuck Marr has a nice little post up on where some of the revenues might come from in this next round of fiscal negotiations.

…policymakers could reform or eliminate many costly tax breaks as part of a balanced long-term deficit-reduction package — or as part of a balanced short-term package to pay for delaying the across-the-board budget cuts (“sequestration”) slated to begin next month, as the President urged today.

For example, the “carried interest” loophole allows investment fund managers to pay taxes on much of their compensation at the 20 percent capital gains rate rather than at normal income tax rates of up to 39 percent.  Other loopholes allow corporate real estate investors to exchange properties without incurring any tax and allow wealthy families to minimize their estate tax liability by undervaluing the assets that they pass on to heirs.

One can only hope that members would rather not screw around with the economy when it’s down—i.e., I don’t believe the -0.1% print from the Q4 GDP release, but I do believe we’re probably looking at below trend growth, and probably slightly higher unemployment, if they can’t partly offset the March 1 sequester with the types of tax revenues Chuck’s referencing here.

We have our own little tax simulator here at CBPP and my colleague NF was kind enough to run this little e.g. to show you what it is I’m talkin’ about.  Imagine a software development manager and a hedge fund manager who each make $250,000 per year.  So this isn’t one of those examples that invokes a rich person paying a lower tax rate than their secretary.  This is comparing two well-off workers but with different income sources.

All the software project manager’s income comes from her paycheck but the vast majority of the hedge fund manager’s income comes from her share of the profits from the fund she manages—her “performance fee”  as they call it.  It is taxed at the favored rate for dividends and cap gains of 20% vs. earnings, which are taxed at 33% for the software developer.

So, plug in standard deductions and so on, and you end up with an effective tax rate of about 13% for our hedgie and over 31% for our software geek.  I’m not even gonna get into who’s actually delivering more value to society.  But I doubt many people will think that’s fair.

This loophole should be closed by now.

Software Development Manager

Earned Income = Total Income: $250,000
Itemized deductions = $25,000
Average tax rate including federal income and payroll tax: 31.5 percent

Hedge-Fund Manager

Earned Income: $25,000
“Carried Interest” (“performance fee” income from the profits generated by the fund): $225,000
Total Income: $250,000
Itemized deductions = $25,000
Average tax rate including federal income and payroll tax: 13.3 percent

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2 comments in reply to "Talkin’ Revenues and Loopholes"

  1. Tyler Healey says:

    I’d love to see the Federal Insurance Contributions Act (FICA) tax abolished. This would have no effect on future Social Security and Medicare benefits because, as James Galbraith has written, “Social Security and Medicare are government programs; they cannot go bankrupt, and they cannot fail to meet their obligations unless Congress decides … to cut the benefits they provide.”

  2. Tom in MN says:

    The way I look at this is that the Hedge Fund manager is the real moocher. Most of their tax is for insurance (medicare and SS) that they get the benefit of directly. By not paying their fair share for all the other stuff, education, defense, etc, when they have the ability to pay, that is real mooching. People on disability, retired, etc, that don’t pay taxes because they already did or can’t is totally different from having a $250k income and expecting a free ride.