Why Taxing Carried Interest As Ordinary Income Is Good Policy

The main points are

1) Carried interest is still a fee. It should not be tax advantaged. It should be taxed like any other fee. This is actually a minor point, the author spends 1 paragraph out of 7 on this.

2) Financial services attracts more capable minds than it should because it can pay better. Taxing it at a higher rate would "level the playing field" encourage "more productive activities". 2a) Raising the tax will not reduce investment because its not taxing the sources of capital more, just the managers of capital more. 2b) Raising the tax will encourage managers to invest more of their own money rather than others' money. This will encourage better performance since they have more skin in the game

3) We need to balance the budget. This is a good source of revenue

I totally agree with point 1 with no qualifications. I don't disagree with point 3 but I'd like to hear a good reason why this is one of the better sources of revenue amongst all others.

I generally agree with point 2a, but don't really agree with point 2b. I agree that having more skin in the game makes you more digiligent and cautious, but the author fails to show that managers don't already have all/most/as much of their money invested in their own fund as they can or the mechanism that causes their risk tolerance to change such that they change their asset allocation.

I have serious issues with point 2. Firstly, carried interest only applies to funds/investments that qualify for long term capital gains treatment. I generally disdain those areas because I think its more fluff than science/business sense, but some areas like VC may require science/technology oriented people who can see the possiblities in the business better than someone who's just an MBA. But if you didn't have smart people deploying capital to these risky technologies because they had a better understanding, then these technologies would never get funded.

More fundamentally however, the author fails to qualify what makes one endeavour more productive than another. Is google productive? They harvest information and profit off of it. Does it make people more productive? Maybe, but I have yet to see a study on the ratio of productive to non-productive searches. In the end, google makes money because they're helping connect buyers and sellers. Is marketing a productive activity?

If someone creates scientific breakthroughs in pharma/chemistry is it still productive if the end use is to make cosmetics or cosmetic treatments for people? Or what if its any technology that creates more free time for people by automating some part of their life. Is it still a productive development if all the people do with their free time is entertain themselves?

Full disclosure : I'm an ex-engineer who last worked at a quantitative hedge fund. I think I'm doing more intersting things and potentially creating "more societal benefit" by arbitraging "mispricings" in the market than I would working in most companies/labs. This is partially because most companies/labs are not doing anything that societally productive, so there's a low bar to cross.

If you feel that taxes are a valid way for a government to implement social engineering, encouraging some behaviors and discouraging other behaviors, than you can't ever complain about the complexity of the US tax code.

I would wager that a lot of people who nod their heads that this is a good idea, also wax poetic at parties about how the tax code is broken and overly complicated.

Main point: while there's a good argument to be made for incentivizing people to invest their capital, there's no good reason why one kind of money manager (or, really, professional of any sort) should be taxed less than another. Just because you work with money shouldn't entitle you to lower taxes, unless you're actually investing your own.

The interesting point that this article brings up is that people are willing to pay a few cents for each share of stock they are selling, but they aren't willing to pay a few cents to send someone to Mars. If they were, then engineering would pay as well as finance.

(A more practical example -- people aren't willing to pay a few dollars to get to their destination faster. We paid engineers to make really cool airplanes like the Concorde, but nobody was willing to pay the premium over conventional 1950s-era technology, so that's what we fly around in today. Money is the answer to everything. The finance industry figured out what people are willing to pay for and how much they're willing to pay, and that's what they charge. Hence, we have ask/bid spreads, $50 overdraft fees, 22% interest rates, and so on. It's apparently how people want to spend their money, and it makes finance a profitable industry. The multi-trillion dollar bailouts are helpful, too.)