Article Examines Taxation of Private Equity Firms

April 3, 2008

Former Tax Foundation researcher Adam Creighton has an excellent piece in this month’s Hoover Institution Policy Review, examining the pros and cons of the recent proposal to impose higher taxes on equity fund managers:

The bill attempts to ensure more consistent tax outcomes for individuals who provide services, and at the same time reinforces the idea that capital gains tax is for individuals who risk their own capital, not for those who manage it. This seems reasonable, but it is not necessarily the “right” outcome.[…]

The Senate bill highlights the special tax consequences of ptps, which offer favorable tax outcomes for certain types of businesses, including those involved in private equity, oil, and gas. This complexity effectively subsidizes these industries, diverting economic resources away from more economically deserving areas and raising taxes elsewhere to fund the subsidy. The Senate bill attempts to exempt private equity from this subsidy – but raises the question of why we have other implicit subsidies, and indeed why we have the ptp form at all.[…]

In a simple tax system, it would not be possible to impose new taxes without actually raising tax. In a simple system, agents could less easily hide behind subtle provisions, and routine “patching up” would be unnecessary. Evidently, complexity allows government to increase taxes or covertly subsidize particular industries more easily. And it creates uncertainty about the interpretation of existing tax laws and deleterious speculation about future ones, which in turn stifle real economic activity.[…]

Public equity would best be served by a wholesale simplification of the current tax code, not piecemeal, ineffective attempts to patch up a Byzantine system.

Read the entire article here.

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