Thursday, July 12, 2007

This Tax Change Sounds Dangerous

I read...
this story
this morning about how the big shots in Washington are looking to change the way that taxes are handled for the managers of large hedge funds. I find it to be pretty interesting when you start thinking about it.

Certainly it is tempting to simply say that since these people are rich, and they can afford it, lets tax the heck out of them. However, I think that this kind of thinking is a mistake. I studied Economics in college and found it fascinating since the beginning of my studies. But when I read this story, some major red flags popped out for me.

If you take the tax break away, you certainly will be getting more income in the short term. However, my gut tells me that there will be a long period of lost money in the long run because less people will want to continue doing business since it is not as lucrative. This will ultimately result in less revenue. Furthermore, many of the ultra smart, ultra rich people will have smarter experts that will still find ways around these laws and shield their money. So, I don't think it is really worth making a change like this.

I generally don't like the idea of punishing the rich. I don't think it usually works. Rich people know how to protect their money. And furthermore, I hope to continue to amass more and more wealth. Sure, I'm not a hedge fund manager, but when you start getting tempted by the money that these people are generating, its only a matter of time until people lower down on the "Rich" cycle are going to get hit up.

2 comments:

Kevin said...

I'm going to have to disagree with you on this one, so let me explain why.

Currently we have a two forms of taxation with bearing on this: taxation on capital gains and taxation on income.

Income is (more or less) what you get without having to risk your own capital. You work. You get paid. You assumed no risk except for the possibility that you won't get paid if you don't do the work properly.

Capital Gains is what you get when you risk your own wealth to create more wealth. Make a bad decision and you not only don't get paid -- you lose what you started with!

In recognition of this difference, capital gains are taxed at a much lower rate than income.

However, there's been a bit of goofiness in how some folks have been allowed to treat their earnings. Some of these hedge fund managers are managing other people's money (not a dime of their own wealth goes in). They take a percentage of any profit as their pay. Since it was a capital gain they are paying the capital gains tax rate on the money.

However, it wasn't their money, so it isn't their capital gain! The capital gain applies to those who put their money at risk. The money made by the manager is based on the capital gain of the funds managed, but they are INCOME since he never had money at play.

It's only capital gains for you if your money was at risk.

The change in the law isn't designed to sock it to them. It's designed to stop them from paying a capital gains tax rate on earned income. Their ability to get the lower tax rate that we give risk-takers is cheating everyone that really is investing their own money with the risk of seeing it lost.

EasyChange said...

Kevin,

Great counterpoints. I can see the point about it considering it income, not capital gains.

However, I find that it is no different than people who are able to purchase stock options for the company they work for at ridiculous prices and then sell them and pay capital gains on the stock shares. Are we going to make all of the small business owners pay 35% on all of their stock option earnings? It takes away the incentive to innovate and produce.


The bottom line is that these fund managers seem like business partners. Really, the money they make is no different than shares of stock in a company (in my view). If you raise the tax from 15-35%, some of these people will stop doing this as work because it wont be worth it anymore. And others will find ways around it.

This really drives right back to my main feeling about taxes. I don't like taxes. I understand that a certain amount is necessary for things like public education, some national defense, and other basic social services.

However, at the end of the article, it is stated that the major impetus for this change is the need to cover the budget gap created by entitlement programs and the war in iraq. Both are areas that we probably should be strongly trying to curb spending at this point. And the democrats who are sponsoring the bill by and large agree about Iraq. So it seems to me that the focus should be on an iraq exit, not a way to finance it for years to come.