Caring about Carried Interest
Under Obama, tax increases are for punishing people who make money in ways Democrats disapprove of.


Kevin D. Williamson

There are tax deductions whose elimination would generate more substantial amounts of new tax revenue. For instance, the tax-free treatment of municipal bonds (an arrangement beloved by many Democrats) is estimated to deprive the treasury of some $30 billion a year, while the deductibility of state and local taxes hoovers about $50 billion a year out of Washington’s coffers. The two combined cost the treasury more than 40 times what the carried-interest treatment for private equity does. Democrats are a great deal less excited about those. Why?

For Democrats in the age of Obama, tax increases aren’t really about feeding Leviathan. They are about punishing people who make their money and live their lives in ways that Democrats do not approve of. There is deeply embedded in their souls a puritanical streak that recoils at the thought of Mitt Romney’s car elevator. Some people in private equity make a great deal of money, and some lose a great deal of money. Your average guy parking his money in tax-free munis is well-off, too — thus making the tradeoff between returns and taxes desirable — but, unlike the private-equity firm, he is entirely passive. But he is putting money into government, while private equity puts money into building companies seeking profit, and so those investors must be punished.

At issue is the question of “sweat equity,” whether we should encourage people to trade their labor and expertise for an ownership stake in a company or enterprise. How people feel about sweat equity in any given circumstance seems to be driven almost entirely by emotion, by whether they are inclined to like or dislike the taxpayer in question. Everybody is familiar with the case of the “Microsoft secretary,” employees of startup firms who agreed to forgo higher salaries (or, in some cases, any salary) in exchange for a share in the company. In some cases, those bets were wildly successful, and people ranging from technology specialists to administrative assistants and receptionists were suddenly able to retire at 40 with millions of dollars in the bank. (The great majority of cases are of course much less dramatic.) Typically, the Microsoft secretary does not put any of his own capital at risk — contributing only his time, his work, his expertise, and his willingness to forgo a guaranteed paycheck today for the possibility of a larger payday down the road. How big a piece of the company he received was the subject of negotiation between him and his employer. Private equity firms do the same thing on a larger, more organized scale, but also put up some of their own money. They contribute work and expertise in exchange for a share of the profits (usually 20 percent) generated by a particular investment, either in an individual company or a group of companies. Those profits are not guaranteed — they do not come automatically; 20 percent of nothing is nothing.

There is very little in the way of persuasive argument for treating the startup worker’s sweat equity differently from the private-equity worker’s sweat equity. You might make a principled argument for treating all income the same (and I am sympathetic to that view), whether it is from salary or investments, or you might make a principled argument for treating sweat equity differently from money-out-of-pocket investments. But it is difficult to make a principled argument that some kinds of sweat equity should be rewarded and others should be punished, which is precisely what the Democrats are pressing for.

Punishing private-equity investors will do almost nothing to balance the books. It would upset a longstanding model of doing business and would put American investors — from Wall Street houses to teachers’ retirement funds — at a distinct disadvantage. That’s a cost-benefit matrix that makes sense only if your bottom line is resentment.

— Kevin D. Williamson is National Review’s roving correspondent.


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