Thursday, December 10, 2009

A tax rant

Well, I didn't intend to start off this blog with a really 'wonky' post, but, hey, I don't control this diarreah of the mind... it just happens.

This has to do with a loophole of tax law (see, I told you it was going to be wonky!)

To understand the context, we need to discuss the business of hedge fund managers, first. A hedge fund manager is somewhat like a mutual fund manager; he/she accepts investment money from individuals or other entities, manages it for the best possible return, and earns a management fee from the result. The usual arrangement can be extraordinarily lucrative for the manager; they normally charge an investment fee of 1% or 2% of the prinicpal, and then also skim 20% of the profits, as their fee. Yes, it's a very high fee, although some hedge fund managers can produce exceptional results, so the clients really don't mind.

So far, that's fine.

Now, here's the problem: the hedge fund managers insist, and the loophole permits, that their management fee be taxed at capital gains rates (15%) instead of ordinary income rates (up to 35%). Their argument: the profit for the hedge fund consists of capital gains, so their percentage ought to qualify for capital gains tax treatment. Preferential treatment of capital gains was established to encourage long term investment, and it makes sense (although I could quibble about the rates applied).

But wait a minute: those gains weren't gains of their money, they were the gains of the client's money! The money going to the hedge fund manager was compensation, not a capital gain. Compensation is the same as salary and wages... why should the hedge fund managers get a whopping break on money that didn't belong to them in the first place?

(Minor adjustment here: most hedge fund managers have some of their own money in the fund, as well as the client's money; the clients feel better when the manager has a little 'skin in the game', even if the exposure is small. My understanding is that the manager's investment is often just a few percent; the gains on THAT part of the money would indeed be long term capital gains, to the manager, and deserves the tax break... but not the entirety of the management fee!)

Anoyhow, the reason I'm writing about this is that I just read that Nancy Pelosi is taking this up in Congress right now, hoping to close the loophole. Let's hope she's successful.

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