Singin' In The Rain
The Democrats and Charles Grassley have proposed an expanded tax on equity partnerships to offset a middle-class tax cut -- a typical soak-the-rich plan that will rain on a lot more people than politicians think. However, it won't soak the people most able to buy umbrellas, according to a new study by the Institute for Law and Economics at Penn. In fact, it will raise much less money than promised, and possibly none at all:
Congressional efforts to more than double taxes on managers of private-equity firms will generate little or no additional revenue to help pay for middle-class tax cuts that many lawmakers are seeking, a new study shows.Buyout and venture-capital firms will restructure their affairs to sidestep any new tax laws aimed at their executives, according to the paper by Michael Knoll, a law professor at the University of Pennsylvania in Philadelphia. ...
Knoll's study may be the first comprehensive, nonpartisan mathematical analysis of the fiscal effects of increasing taxes on so-called carried interest. It signals an uphill battle for lawmakers trying to raise the money needed to pay for eliminating the alternative minimum tax for about 23 million mostly middle-income households.
``What seems to some folks as an easy fix isn't quite as simple and clean and won't generate the kind of revenue they expect,'' said Drew Maloney, a principal at Ogilvy Government Relations, which was paid $3.7 million in the first half of this year to lobby Congress on behalf of Blackstone Group LP, a private-equity firm fighting a higher tax burden.
The study itself reached the common-sense conclusion that taxes disincentivize equity partnerships and the realization of profit. Expand those taxes, and the money will simply get channeled in different structures. Knoll's concluding paragraph states:
It is, however, likely that the structure of private equity funds will change if the tax treatment of carried interests is reformed. One possibility is that private equity funds will shift the obligation to pay the carry from the limited partners to the portfolio companies themselves. Assuming that successful companies can use the deduction – an important assumption that is not free from doubt – the tax saved by the portfolio companies will approximate the additional tax paid by the general partners. It is, thus, possible that there will be little or no net increase in tax collections from taxing carried interests as ordinary income and accelerating taxation to the grant date once the structure of private equity funds adjusts in response.
Knoll did not get corporate financing for this analysis; in fact, he got no outside financing at all. He has no particular axe to grind. All he wanted was an accurate analysis of the impact this tax would have on the budget.
We've talked about the difference between static and dynamic tax and economic analyses before. People who propose tax increases and economic policies believe they will take place in a vacuum. They calculate revenue based on the notion (in static analysis) that new policies will result in no changed market behaviors. That leads to a number of very faulty and very costly conclusions.
The Smoot-Hawley tariff bill that triggered a worldwide depression might be one of the most well-known examples, but almost any tax increase that purports to close loopholes or raise a certain amount of funds also exemplify the problem. Increasing taxes on cigarettes to pay for increased health coverage will result in less cigarettes being sold -- which is beneficial in itself, but also leaves the government short of the revenue it assumed it would have for the budget. Artificially raising costs for any product in a market disincentivizes consumers from buying it.
Knoll's study uses dynamic analysis to capture the market effect of the policy and tax change to understand its impact. It provides a more realistic estimate of the costs and revenue of the tax adjustment, and shows that it will follow in the tradition of other such economic policy changes -- it will overpromise and underdeliver. It will tend to hit those who cannot afford to dodge the storm, the smaller and medium sized investors, while leaving the real targets of the class-warfare policy dry, and singing in the rain.
Posted by Ed Morrissey on August 23, 2007 10:30 AM | Comments (10) | TrackBacks (0)
Comments (10)
Posted by Captain Ed | August 23, 2007 11:20 AM
test on comments
Posted by Captain Ed | August 23, 2007 11:35 AM
test 2 on comments
Posted by Sensible Mom | August 23, 2007 11:48 AM
Similarly, the gripes about lost revenue when tax cuts are proposed are often wrong.
As we saw with the Bush tax cuts, government receipts actually increased because the extra money available to investors/entrepreneurs was funneled into the economy and market, and allowed them to grow.
Posted by AW1 Tim | August 23, 2007 11:50 AM
Cap'n,
These sorts of tax schemes usually backfire on their proposers, and, in the end, the taxpayers themselves end up getting hosed to cover the losses.
As an example, Maine increased the taxes on cigarettes, and budgeted for a revenue increase, based upon those same taxes, of 67 million dollars. The Democrat controlled state legislature them alloctaed those still uncollected, but expected, tax revenues towards other programs.
However, many smokers simply stopped smoking, reduced their smoking, or found other types or sources of tobacco and, as a result, the amount of expected revenue was significantly curtailled.
Now, the legislature is forced to seek further taxes or other sources of revenue to make up the difference, since they have already spent the income they thought they would get from the tax increase.
It's so sadly typical that legislators fail to review historical data on such schemes before deciding to implement them.
Governments can only suck so much taxes out of the population before the citizens start to find ways to reduce the impact on themselves.
respects,
Posted by rbj | August 23, 2007 12:00 PM
The wealthy hire accountants and tax lawyers to ensure that they can get around new taxes. The really wealthy hire politicians to ensure that they aren't included in new taxes.
There is far too much time, effort and money being spent on complying with/avoiding taxes. A much simpler tax code is needed, one that has low rates but few, if any, exemptions.
And another consequence of increased cigarette taxes is the increase in cigarette theft.
Posted by LarryD | August 23, 2007 12:05 PM
I wish it were possible for the proponents of these taxes to become personally dependent on them working as advertised. Say, their pay and benefits would only be payed out of the revenue generated, not out of any other revenue streams. Then they'd learn basic economics, I bet.
One idea I've had on government budgets, given the poor quality of revenue predictions, is to base the budget on the prior years revenues. This means the government is spending the previous years income. This means the government would be running a surplus if the economy is growing and a deficit if it is shrinking. That's what Keynes advised, only the politicians could never bring themselves to run a surplus, so what they actually did was run a deficit, regardless of the economy.
Posted by Mike Caputo | August 23, 2007 12:08 PM
One idea I've had on government budgets, given the poor quality of revenue predictions, is to base the budget on the prior years revenues. This means the government is spending the previous years income. This means the government would be running a surplus if the economy is growing and a deficit if it is shrinking. That's what Keynes advised, only the politicians could never bring themselves to run a surplus, so what they actually did was run a deficit, regardless of the economy.
Posted by Mike Caputo | August 23, 2007 12:20 PM
Testing Post
Posted by Tom Holsinger | August 23, 2007 12:21 PM
Ed,
The sole purpose of raising taxes on the rich is to raise campaign contributions. Revenue has nothing to do with it. A nominal tax increase for the rich is only a vehicle to subsequently sell tax breaks to the same group in exchange for campaign contributions.
Posted by FedUp | August 23, 2007 12:51 PM
Is it only me, or does anyone else feel that there should be some qualifications to be elected to congress other than breathing... or being from the 'right' party???