Alice & Bob form a partnership to invest some money. Between the two of them they invest $100. After 5 years they sell their investment for $200. As far as the government is concerned, that's a long term gain of $100 and should be taxed as such. How Alice & Bob decide to split the gains is between them and not a tax question.
I don't necessarily buy this argument, but it's a valid way to look at things.
The interesting point is why do hedge fund manager labor income get taxed at a different rate then all other labor which you have not addressed.
Why should risking time and risking money get taxed at different rates? I guess I don't understand the argument for why LPs should pay less taxes than GPs. Especially since entrepreneurs get to pay longterm capital gains on their stock, and the risk profile of being a founder is basically identical to the risk profile of being a GP.
When I said that "I don't necessarily buy this argument", I didn't mean that I necessarily disagreed with it either. TBH, I remain uncertain.
It's interesting that you compare founders/GPs/LPs without bringing up employees. They also risk their time and, in a majority of cases, will not receive preferential tax treatment.
When speaking about employees, I was talking about startup employees who take a significant % of their compensation as risky stock options. My point was about this portion of their compensation.
Startup employees generally get equity in the form of stock options. In order for employees to get preferential tax treatment on these options they have to exercise these options at the time they are granted (which can require a large outlay of cash) and then hold them for at least one year.
Due to the cost and risk of this exercise, most employees do not do this. Instead they wait to see if the company becomes more valuable (and liquid) and only exercise the options if so. At that point any realized gains are taxed as ordinary wage income.
There are a great many resources online on this topic if you are interested in more details.
EDIT: after reading more about it, it actually makes sense. What really employee is getting is an "option" similar to one can buy for publicly traded companies. And whatever option price is already reflected in employees tax situation - it is an actual expense which lowers tax base by the cost of this option.
Now - the cost of that option (i.e. different between full salary and limited salary when getting options) is something that can be very incorrectly priced (which I assume is the case in the majority of startups)
So it is not tax code discriminating against these employees. It is actually employers taking advantage of these clueless employees.
Certainly it is in some cases, but in others the employees could have a high enough risk tolerance that it is a good deal for them.
In addition employees also often make career decisions on factors that are not purely financial. This is also a perfectly reasonable thing for people to do.
As for non-financial reasons - this is 100% valid point. But then why we are talking about non-fair taxation? Stocks come into picture only when employee exercise (at a nominal price on the moment employee was hired) The same would apply if you use regular options for the publicly traded company on RobingHood for example.
GP gets 2% in management fees. That's a guaranteed return for his time.
Then 20% of the profits.
Only at the most senior level. Most GPs only get carry, and then maybe 40 - 60k a year of salary if they get any salary at all.
And for the ones that do get management fees, they pay normal taxes on that.