NEW YORK CHALLENGES A TAX PRIVILEGE OF THE RICH

“Two Democratic members of the New York State Assembly, Jeffrion Aubry and Sean Ryan, introduced a bill this week to close the ‘carried interest’ loophole, which lets partners in private equity firms and hedge funds pay a greatly reduced federal tax rate on much of their income.

“The measure is the most innovative of several to close the loophole. Several bills in Congress on the issue have gone nowhere. Congress has also ignored repeated calls from President Obama to close the loophole. Even bipartisan calls to close the loophole — from presidential candidates as diverse as Hillary Clinton, Donald Trump, Bernie Sanders and Jeb Bush — have not moved Congress.

“New York’s proposal would get around this congressional inaction by raising state income taxes on private equity and hedge-fund partners who live in New York. The increase would be equal to the tax savings they receive from using the loophole at the federal level.

“Partners at private-equity firms and hedge funds typically treat a big portion of the fees they charge their clients as a capital gain — that is, as profit on the sale of an investment — so they can pay tax at the capital-gains rate of 20 percent (plus a surtax of 3.8 percent typically). Ordinary income is taxed at a rate of up to 39.6 percent. But labeling fees as capital gains is a stretch, in part because the partners generally earn their fees by managing other people’s money, not by investing their own.

“The New York bill is supported by a coalition of activists focused on inequality and tax fairness. The group plans to work with lawmakers in nearby states on similar bills. The aim is for the tax increase to take effect once various states have closed the loophole. That way, the tax could not be avoided by moving to a neighboring state.

“The bill’s supporters estimate that closing the loophole would raise $3.7 billion a year in New York.  Estimated annual income would be $938 million in Massachusetts, $535 million in Connecticut and $112 million in New Jersey.

“Virtually every tax dodge involves somehow passing off relatively high-taxed ordinary income as low-taxed capital gains. The best solution would be for Congress to do away with special low tax rates for capital gains. But for now, the New York bill and the push for similar legislation in other states could offer a bold and smart step forward.”

New York Times editorial, March 11, 2016.