Wednesday, April 16, 2008

Congress subsidizes hedge fund billionaires

The New York Times reported yesterday that:

Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street’s rarefied realms.

One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them.

Mr. Paulson... was not the only big winner. The hedge fund managers James H. Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor’s Alpha magazine....

Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again.

Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry.

Even on Wall Street, where money is the ultimate measure of success, the size of the winnings makes some uneasy. “There is nothing wrong with it — it’s not illegal,” said William H. Gross, the chief investment officer of the bond fund Pimco. “But it’s ugly.”

What's really ugly, even obscene, is that these billionaire managers pay lower tax rates on most of their income than millions of middle and working class Americans.

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 because they are allowed to claim their income as capital gains which is taxed at a low 15% rate.

This exemption makes little sense: in economic terms, the fund managers (also known as investment advisors) perform professional services, much like lawyers or doctors, and are paid for their expert labor.

But it one reason for the growth in inequality. Since 1913, the United States has witnessed only one other year of such unequal wealth distribution — 1928, the year before the stock market crashed.

So why does Congress provide private equity and hedge fund managers with this hand-out?

As the notorious bank robber Willie Sutton proclaimed when asked why he robbed banks: "Because that's where the money is!"

Members of Congress know that this costly subsidy greases their palms with large campaign contributions!

Dean Baker writes: 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.

... 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.


1 comment:

John P said...

Mr. Rosen:

I usually disagree with you on most things, but you are right on here. I am a CPA. who performs tax planning and tax prep for many people in all income brackets. It is not right that a hedge fund manager's "carried interest" gets taxed at capital gains rates. I think that this should be changed. If it someone's job to invest, like hedge fund managers are, then all of their compensation should be subject to ordinary income tax rates. I also believe that some one who makes their living off of investments should have those earnings taxed at ordinary income rates, except for people as of retirement age. I think people who do not derive most of their income from investing should have their investment income taxed at the current capital gain and dividend rates.