Proponents of raising taxes on money managers at hedge funds and private equity funds often discuss the issue as if it were a simple matter of tax fairness. The taxation of the 20% “carried interest” fund managers charge at the lower capital gains rate is treated as a loophole or even a subsidy for fund managers. It’s survival is attributed to nothing but the power of hedge fund lobbyists.
What they carefully elide is the fact that the reason the work of hedge fund managers is taxed like investment activity is because the work is investment activity. That is, when hedge fund managers are running client money they are doing what every other investor whose gains are subject to capital gains taxes does–deciding what to invest in, arranging financing, deciding what to sell and what do short. They are acting as investors.
It makes no difference whatsoever that hedge fund managers are using the funds provided by their limited partners. Lots of investors use funds provided by others. In fact, every single trader with a margin account is doing this.
So next time someone tells you that they want to tax carried interest at a higher rate because of “the principles of tax law,” ask them why investing by hedge fund managers should be taxed more than other investment activities. That’s really what a higher rate for carried interest would mean.