Friday, March 9, 2012

The carried interest exemption

Carried interest as an exemption isn't easy to defend:
The other problem is that private equity partners are not actually like Dan the carpenter. If Dan and Ms. Moneybags are in a true 50-50 partnership, then Dan is on the hook for half of their losses, as well. The great thing about 2 and 20, for private equity partners, is that they get a cut of the profits but they don’t absorb a share of the losses. This means that the 20 is more like a performance bonus than like a partnership share. So if the 20 is in a gray area, as Mankiw argues, it is even closer to ordinary income than Dan’s partnership share—which, as Mankiw shows (although he doesn’t quite come out and say it, for obvious reasons), should be treated as ordinary income
I have begun to wonder if capital gains should be taxed at a different rate than income, especially if we have exemptions on gains resulting from housing (as transaction costs with housing can reduce mobility).  But the only argument for capital gains exemptions (that people have to risk losing their money) clearly isn't applying to hedge fund managers.

But no matter how one looks at this situation, the best that can be said is that some people may sneak labor wages in as capital gains.  But should we not be trying to limit the cases where this happens and not encourage them?

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