Congress's Carried Interest Tax Folly

From the Wall Street Journal:

Nero fiddled while Rome burned, but at least he didn't strike the match. Members of Congress are doing Nero one better. In the middle of the second global financial crisis in two years, Congress is preparing to dramatically raise a key tax rate on long-term investment. This is sure to discourage capital investment, increase the cost of money to start and grow businesses, and depress real-estate and stock prices, all at the worst possible time.

Last week, Senate Finance Committee Chairman Max Baucus (D., Mont.) and House Ways and Means Chairman Sander Levin (D., Mich.) released joint legislation that would among other measures significantly raise the tax on "carried interest." Now the tax rate on these long-term capital gains earned by the general (managing) partners of investment partnerships is 15%. The new law would raise the rate to as high as 38.5% (three-fourths of the gain would be taxed at ordinary income tax rates and one-fourth at capital gains rates, both of which will be increasing as well).

Tax rates matter. And what matters about them is what activities get taxed, not who gets taxed. When you increase the tax rate on an activity, you get less of it. The only question is how much less of it you will get.

Congress should be asking one question: "Is long-term investment something we really want less of, especially now?" Unfortunately, in today's political climate, tax policy discussions focus almost exclusively upon whom, not what, gets taxed. This means singling out specific groups of people—bankers, Wall Street, "the rich," the owners and executives of insurance, oil and drug companies—to punish for our economic difficulties. This may be politically popular but will have bad consequences for the economy.