Okamoto and Breenan: Measuring the advantage we give hedge fund managers through the Partnership tax break

I've argued here that it is entirely inappropriate to permit hedge and private equity fund managers to be taxed on their compensation for services at the capital gains rate when ordinary wage earners pay the higher ordinary income rate.  It's particularly unfair, since these managers are merely using other people's money to get rich, and then using Uncle Sam's welfare for the elite to get even richer.  They are not really entrepreneurs, as they argue, but more likely either risky speculators or highly paid destruction crews.  It is these private equity funds, for example, that are able to buy businesses, rip them into pieces, and then resell at a gain.  Often workers are lost along the way, or the jobs are exported overseas.  In this "greed is good" climate engendered by the "free marketarian" fallacy coupled with the MBA in charge who knows very little about fostering a healthy work environment, nobody seems to care about that anymore.  All in all, a situation crying out for change, if only the Senate can be strong enough to take action that will impact a very few people who are very, very wealthy.

Karl Okamoto and Thomas Brennan have put together some empirical research on these hedge fund managers:  Measuring the Tax Subsidy in Private Equity and Hedge Fund Compensation.  Here's an excerpt from their abstract.

[O]ur model suggests that differences in tax account for a substantial portion of the disjuncture that exists at the moment. It also quantifies the significant excess returns to private fund managers that must be taken into account by arguments in support of their current tax treatment by analogy to entrepreneurs and corporate executives. This analysis is important for two reasons. It provides a perspective on the current issue that has so far been ignored by answering the question of how taxation may affect behavior in the market for allocating human capital. It also provides quantitative precision to the current debate which relies significantly on loosely drawn analogies between fund managers on the one hand and entrepreneurs and corporate executives on the other. This paper provides the mathematics that these comparisons imply.

Comments

[andy]

"highly paid destruction crews"

"then resell at a gain"

If they are destroying the businesses, why are they being resold at a gain? I would think that if you destroy something, then it's worth less.

[andy]

also, to follow up on a point I made previously, I am not sure what the following phrases add to the (undoubtedly viable) arguments that can be made in favor of changing the the tax treatment accorded to hedge fund managers (these phrases instead completely obfuscate whatever point you may have been trying to make):

"using other people's money to get rich"

"using Uncle Sam's welfare for the elite"

"highly paid destruction crews."

"'free marketarian' fallacy coupled with the MBA"

[LindaMBeale]

Andy
Most of the managers who earn 2 and 20 (or, for some, 3 and 30) admit that they are making money using "other people's money." There's nothing accusatory about that--it's a mere statement of fact. Of course, it's a fact that is often hidden, as lobbyists for these managers insist that they are just great entrepreneurs.....

As for "Uncle Sam's welfare for the elite"--that is a good description, isn't it, of a system that provides a huge break to the very wealthy on their compensation taxation in the face of much higher rates on compensation for other types of work. We are quite relaxed about calling various supports for people at the bottom "welfare". I haven't seen you object, for example, if I talk about the importance of welfare for the poor. Why not use the term, when it applies, for people at the top as well?

From my perspective, permitting the "carry" in partnerships to be taxed favorably after lobbyists spent considerable money and time pushing for that result was an explicit decision to provide "welfare" to these managers. They don't need it, and it is unfair. So let's call it what it is, and then maybe Congress will eliminate it.

I assume that one reason you don't like any of these phrases that you have listed is likely that you buy into the "free marketarian fallacy" and therefore tend not to agree with the problems I point out. I coined that term as an apt phrase to describe the too-strong reliance on one view of the interrelationship between capitalism and democracy and the problems that result when "free markets" (which aren't really "free" but depend on the institutions established by government) are used to justify approaches to the economy that can create
huge gains for a very few at the top of the economic pinnacle with huge costs in stagnation and economic losses for others. The phrase sums up the false economic reasoning of the last thirty years that has led to increasing inequality and control of the financial resources by an elite few.