Subsidies for Fund Managers: Wall Street's Giant Trough

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Dean Baker
Truthout, July 16, 2007

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We all know about the proper role of government - giving as much money as possible to those who already have the most. That is the principle behind the special tax treatment of compensation for managers of private equity and hedge funds.

The basic story here is very simple. Most workers have their wages taxed as normal income. Low and moderate income workers typically pay tax at a 10 or 15 percent marginal rate. More middle class workers, like teachers or firefighters, generally face a marginal tax rate of 25 percent. Higher paid professionals, like doctors or lawyers, will generally face a marginal tax rate of 33 percent. Very high-end workers pay a marginal tax rate of 35 percent; that is, unless they manage a private equity or hedge fund.

In its infinite wisdom, and search for campaign contributions, Congress decided equity and hedge fund managers needed a special hand from the government. Therefore, instead of paying the normal tax rate on their earnings, Congress decided these managers should just pay the 15 percent tax rate charged on investment income.

This is real money. Hedge fund managers often make more than $100 million a year, and some have earned more than $1 billion. For those in the $1 billion club, this tax subsidy is worth more than $200 million. That's enough money to pay for health care coverage for more than 70,000 children. It could provide child care for almost as many kids. This is almost one-tenth as much as the United States contributes to efforts to combat AIDS in Sub-Sahara Africa.

We all know fund managers have it tough - the price of yachts, vacation homes, top colleges and private jets has been soaring - but it's time for the boys and girls (almost all boys) to stand on their own two feet. They should be able to make ends meet without a special subsidy from the government.

Just to be clear, this tax break is not an arguable point. This is not like the Bush tax cuts, where there is at least a plausible argument the incentives created by lower tax rates will create enough growth that they are worth the loss in government tax revenue. The evidence shows lowering tax rates leads to little, if any, increased growth, but it is at least possible investors and workers would change their behavior in a big way in response to lower tax rates.

By contrast, it is difficult to even imagine an argument as to why the government should subsidize equity and hedge fund managers. Proponents of these tax breaks say these managers take a risk. This is true in the sense they get paid on commission, but so do realtors and shoe salespeople. I haven't seen any members of Congress proposing special tax breaks for realtors or shoe salespeople.

In fact, if we want tax breaks that compensate for risk on the job, fund managers probably would not stand at the top of the line. How about firefighters, police officers or poultry workers? All of these workers face much greater risks on their jobs, but none of them get special subsidies from the government.

Fund managers may not have much of an argument as to why they deserve a special tax break, but they have something worth much more in Washington politics: money. They have filled the pockets of candidates of both political parties. That is why the Fund managers are likely to keep their tax subsidy.

But, we should thank the fund managers because they have done the country a valuable service. Since there is no rationale for the fund manager tax break, we know any member of Congress who supports the tax break is doing it for the money, pure and simple. In short, the fund managers have given us the equivalent of a DNA test to assess political corruption. Let's see how many members of Congress flunk the test.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.