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Comment by MR4D | Hacker News Reader

Carried interest is effectively the General Partners share of the dividend. Dividends are taxed at a lower rate than ordinary income, so this is as well. This is true whether you’re poor and own one share of a dividend paying stock, or you’re Ray Dalio.

Here a pretty good breakdown of how it works and why it makes sense [0].

To be clear, I’m not saying you have to like it, but the rich have been getting richer since the beginning of time. I don’t expect that will ever change. It’s as true with humans as with animals like lions (albeit the measures are different, as lions have no care about dollars).

[0] https://www.cnbc.com/2014/03/04/cnbc-explains-carried-intere...

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Yes, but as the parent article states, and even what is pointed out in your own link, while dividends are taxed at a lower rate, the manager is paid the lower rate on capital that is not his to begin with. That's the part that makes no sense to me. It is quite simply an incentive payment for his labor: it's income that investors pay him for his expertise, and as such should be taxed at income rates.

You & I start a company. I provide $100,000 in seed money but little actual work/time. You provide no seed money but a lot of work & time. We agree to split ownership of the company 50/50.

5 years go by.

We sell the company for $1,000,000. You get $500,000, I get $500,000.

Should I get to pay a lower tax rate than you?

Then let hedge fund managers organize their funds as equity purchases from their investors. To use your analogy, if managers were deserving of 20% of the profits, then structure it as investors own 80% and managers own 20%.

Of course, that would make many hedge funds a lot less attractive for many investors. Hedge fund managers want to have their cake and eat it too.

That is (more or less) what hedge fund managers do.

I know they are organized as partnerships, but the managers don't really have any equity rights to the committed capital, only the profits. But I guess that's really no different than an investor with preference rights in a startup.

In any case, thanks very much for your explanations, really helped me think about the issue in a different way.

Happy to help out!

In any case, as I stated elsewhere(1), I'm actually not sure what I believe on this topic. I can really see it both ways.

1. https://news.ycombinator.com/item?id=17276214

No. You shouldn't. The person doing the actual work should be paying it as tax on labor, and the person who put up the funds should be paying it as capital gains. And obviously, capital gains should be taxed at a rate greater than labor.

That is a fine point of view, but perhaps outside the scope of the topic under discussion.

The parent poster is saying that carried interest should be capital gains taxable to avoid having it in the higher bracket, as it would be if it were taxed as wages. Thus, the idea that it is wages but that should be cheaper than capital gains answers the issue.

Uh, what?

You want to make it more expensive to increase productivity? (Because that’s what capital does - it gets invested to increase profits).

The logical path you’re going down would replace road builders with people with spoons to move dirt around and file down rocks with spoons to put them in the ground to walk on.

Seriously, if you consider the logical conclusion of your argument, we end up in madness.

That's nonsense. The gains of investing in a work crew still make money for capital. They still get their income. The increase in productivity is its own reward - the road gets built faster or with less labor, you're able to out-bid your competition. It makes more sense to extract money from the people who contributed money than from people who contributed labor.

Nonsense?

#1 You’ve just discouraged capital investment.

#2 you’ve just agreed with my initial statement that there is a reason carried interest is taxed the way it is. If you tax capital more than labor, then by definition, carried interest is fine, because the people who pay it ARE THE PEOPLE DOING THE LABOR!!

Seriously, I realize that this is an emotional topic for many people, but you have to think through the second order effects. The first effect is pretty simple, but in this case the second order impacts have all sorts of ramifications.

I’m fine with people having their opinion and feeling that something is right or wrong - that’s healthy. What’s not healthy is having an opinion that is either self-contradicting, or made out of frustration.

Think through the scond order effects. Harry’s gave a great exam-let that showed just one simple version. There are tons more.

Carried interest is a misapplication of the idea of labor. Of course it's fine that they're taxed less than people who put up only money - but I disagree with the entire idea of capital taxation being less.

Capital investment is discouraged, but it's not as if it's going to stop due to this discouragement. What are people going to do with their money, NOT invest it? Found their own companies instead? Acquire capital assets and lease them? It's not as if you can work _instead_ of capital gains, cap gains income is passive.

Capital gains taxes in the US have been higher in the past, and at several points, were higher than wage taxes are now. Things worked out fine.

Cap gains are absolutely NOT passive.

I build a company. Work my fingers to the bone for years, and take a significantly reduced salary compared to my market value. Later I sell it for a billion dollars.

That is taxed as long term capital gains. Are you saying that’s passive? Sure, you buying a few shares of Ford is passive, but tons of capital gains like in my example are not.

Also, you comment “that came out fine” is rather flippant. When you dominate the world after a world war, pretty much everything is going to go your way, whether you tax income at insane rates or make black people drink from separate fountains. Both occurred in the same time period. If you use you’re argument that “things worked out fine”, why not also keep that around? I think the reason is we’ve managed to see that correlation doesn’t drive our decisions there. And they shouldn’t in taxation either.

This analogy doesn't work; carried interest isn't granted because of any sort of ownership stake.

That is not correct. Hedge funds and VC funds are generally organized as partnerships. The General Partners (GPs) are just as much owners as the Limited Partners (LPs).

No, you have risked nothing but your time. Since you have no investment at risk you should not get preferential tax treatment meant to encourage you to do so.

(I think you might have inverted the "I" and "you" in my scenario making your comment a bit confusing. But I think I understand the point you were intending to make.)

Why is the risking of money deserving of special tax treatment but not the risking of time?

I personally don't think it is but that is the logic used to justify the capital gains tax.

FWIW, the common rebuttal scenario goes like this:

You and I earn $200k in wages, and each pay $100k in taxes. You spend your remaining $100k on a boat. I invest my $100k, and 5 years later it's worth $200k. Suppose that $100k gain is taxed like ordinary income at 50%. After taxes I have $150k, which I also spend on a boat.

Without taxes, you would have had $200k to consume in year 0, but you actually got $100k; your effective tax rate is 50%. Without taxes, I would have had $400k to consume in year 5, but I actually got $150k; my effective tax rate is 62.5%.

Who should pay the higher tax rate? The person who consumes their wage income immediately, or the one who defers consumption? For them to be equal, the capital gains tax rate has to be 0%.

My comment was providing a defense of preferential tax treatment for carried interest.

You provided an argument for a 0% tax rate on capital gains.

I'm not sure how your comment is a rebuttal to mine? Perhaps you responded to the wrong comment by accident?

Your example seems to have nothing to do with carried interest. There's a single investor; no investment manager. The question around carried interest is whether certain types of income earned by investment managers should be classified as labor or capital income, whereas you have one person with labor income and one person with capital income, and are asking who should be taxed more heavily.

In my comment "I" am the investor and "you" are the investment manager.

I'm sorry if that was unclear.

I think harryh ‘s comment states everything I could but much more succinctly, so I’ll just second his statement.

If the point of lower capital gains tax rate is to incentivize risking capital then the carried interest loophole makes no sense because the noney manager isn't risking his capital. His "share of the dividend" is just another fee that should be taxed as any other income.

If you want to discuss “fair”, I’d tend to agree with you. But taxing them while not screwing out all the other business structures that look just like this (see harryh’s example above) is damn near impossible. Which is why the exemption is in there. Figure that out and it might change. Until then, you risk screwing up all sorts of businesses that are not financial let alone hedge funds.

> the rich have been getting richer since the beginning of time

That's not true and we must be careful not to accept an aristocracy (or oligarchy) as inevitable. That the wealthy will inevitably hold and consolidate power is counter to the history of democracy, a specific rejection of aristocracy, and a system which has worked the other way in country after country to great success economically and politically - great news and great hope for humanity in these times. The foundation of the U.S. is that all are created equal, and after that it's a land of opportunity where merit wins out, not inherited wealth and corruption.

If by that you mean that rich have been getting richer relative to others, that's certainly not true. In the U.S. it's been true since the 1980s, but it fluctuates and in most other advanced economies the proportional difference (the disparity) is much less.

If you mean that there is not downward social mobility for the rich, that's also not true. I don't have the numbers, but I've read about research that overall social mobility (up and down) is significantly less than it was before Reagan. There's also the old American family story: Rags to rags in 3 generations. More concretely, the U.S. used to have higher taxes on the high income, and more importantly, a (much higher?) estate tax: Inherited wealth is not merit, but effective aristocracy. That said, I don't know the inter-generational overall trends of wealthy families.

(Or maybe the parent means something else.)

EDIT: Some clarification + the last sentence

The idea of democracy as a “rejection of aristocracy” has been well discredited for centuries now.

The topic of discussion here is not “social” but economic mobility. Let’s not mix them up so carelessly. Economic mobility is a measure of ability, or potential, not concrete events. To discuss “downward” economic mobility is to imagine wealth being forced upon these folk.

I’ll pick out one point that you seem to miss - when the US taxed the heck out of people with high incomes, you still had people like Howard Hughes, Warren Buffet, and John Paul Getty becoming even richer than they were before.

So yes, the rich get richer, and high taxes do not stop that (but present the illusion that it stops ).

I’ll gladly admit I’m wrong if you can disprove my three simple examples. Last I hexked, they were R I C H.

You do realize that you can still have some very rich people and still have a more equitable distribution of wealth than we have today, right?

I never made that argument. Reread my comment.

I don't think three examples are representative of the wealthy overall. I didn't say 'no rich get richer'; beyond a doubt, some do - and that's fine and fully compatible with meritocracy. The question is, what is the overall trend? Is there social mobility, opportunity and meritocracy, or aristocratic power and inheritence?

Ok. Interesting point you have. But let’s dive into something that shows how statstics can get really skewed:

Take money 100 years ago. The richest guy on the planet (ignoring royalty, as those figures aren’t reliable) was John D Rockefeller. He was worth a ton of money, possibly even a billion dollars. Today’s richest man in Jeff Bezos, worth about 100 times that (depending on the stock price, somewhere roughly between 100-125 billion).

So today, people say that the wealth gap is growing. Indeed, the rich are richer.

However, at his peak, Rockefeller was worth about 1.5% of GDP ( a truly crazy sum of money that equates to roughly $350 billion today).

So if we look at inflation-adjusted money, the rich are poorer than they were 100 years ago - indeed, Rockefeller was about 3 times richer than Bezos.

So depending on the metric, the rich are getting richer, and wealth disparities are growing. But when you normalize for inflation one other factors, the disparity is not growing.

Also, if you take the poorest person at the world with zero dollars, and the richest person in the world with one more dollar, than the wealth disparity is growing, and headlines shout out crazy stuff that sets everyone’s emotions.

But zero will always be the lower bound, and the number at the top will always grow (assuming inflation).

So is disparity growing or now? Well, I think the best way to answer that is ask this question: “would you rather be you today, or Rockefeller 100 years ago?”

I’d rather be me. Between the internet, healthcare, cars, planes, etc, I’m way richer than Rockefeller, because despite all that money, he couldn’t begin to buy those things. So society has gotten much richer, and the disparity between me and Bezos is smaller than between me and Rockefeller. Also, I don’t have to really be worried about dying from the flu. Rockefeller did - even a simple infection could kill him, but unlikely to kill you or me.

Economists aren't stupid, and they've thought of these things like zero lower bound. This is a well-studied issue. When people say the concentration of wealth is increasing, they aren't saying it's increasing relative to Rockefeller's time (how far back should we go? 1492? The start of the neolithic?), but it's increasing now, such as over the last few decades.

I get your point, but have a couple issues. First, there are plenty of stupid economists. Just like there are plenty of stupid people in finance or politics, or many other things.

But I’m not going to debate that particular thing, and I’m fine if we disagree. *

That being said, the timespan question is very valid, but pinnning down the cause is really hard.

If you read the research, the highest correlation is with globalization, not taxes. Let’s pretend you fully buy into that statement. If so, would you argue against globalization? And I mean that as a serious question. This is a really hard problem, and the answers are more like foggy hints than anything else. But if we’re really honest with ourselves, and the answer was yes, what should we do about it? Taxation is hard because it immediately districts the natural market and causes many second order effects. Pulling those apart to understand the root cause is really hard and few people can do it at all, let alone well.

*My main issue is that economists tend to have a poor understand of statistics and cause and effect relative to what they need to really do their job. If you listen to Ed Yardeni, he basically throws out all macro-economics as being a sad state of affairs given how bad their models are compared to the reality they’re supposed to predict. Still worse, novel prize winners continue to spout their theories after they have been proven empirically wrong. Hence my general issue with the field. Some are clearly smart, but enough aren’t that gives me great pause.

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