Millionaire's Tax: Hedge Fund ‘Carried Interest’ Tax - 15% - May Be Biggest U.S. Tax Loop Hole

Senate Majority Leader Harry Reid, D-Nev., is expected to introduce his 5 percent millionaires tax surcharge Tuesday in the Senate, but another issue regarding tax fairness is making the rounds on Capitol Hill: raising the carried interest tax.

Carried interest is the portion of hedge fund/alternative investment manager's income that stems from a manager's performance, and it's nice work, if you can get it. Here's why:

Management fees are taxed at the ordinary U.S. income tax rate: 35 percent, 33 percent, 28 percent, 25 percent, or 15 percent, depending on the person's income.

However, an investment manager's performance is taxed at the capital gains tax rate -- only 15 percent.

Carried interest is one of the biggest loop holes in the current tax law -- and one that costs the U.S. Government billions of dollars -- the 20 percent differential that encourages tax filers to find ways to reclassify wage income as investment income.

Obama Wants Law Changed

I reject the idea that asking a hedge fund manager to pay the same tax rate as a plumber or teacher is class warfare. President Barack Obama said, hedgefund.net reported Monday.

Liberal and populist groups generally favor Obama's proposal because of what they argue is a flaw in U.S. tax law. The currently policy means alternative investment manager can end up paying a lower percent of their income in federal income tax than middle-income and working-class adults.

Conservatives, including almost all if not all Congressional Republicans are against closing the loop hole for carried interest. They argue that taxes are already high enough on the wealthy -- and that upper-income groups already pay a disproportionate share of federal taxes. The GOP also argues that raising taxes will reduce business investment and discourage initiative.

Closing the loophole for carry interest would raise an estimated $18 billion in federal revenue. Meanwhile, Reid's 5 percent surcharge would increase federal revenue by $447 billion, the Congressional Budget Office estimate.

Political/Tax Policy Analysis: The carried interest loop hole is one of the egregious injustices in the U.S. tax code, and Congress should eliminate it post-haste.

The notion that an office secretary or janitor or construction worker would pay a higher tax rate than a hedge fund manager making $5 million, $10 million, or even $20 million per year is intrinsically un-American and unjust.

However, the Republican-led House will veto any tax on upper-income Americans, hedge fund manager, or not. Hence, for voters, the option is basic: re-elect Republicans if you agree with current law, vote for Democrats if you'd like to see the carried interest tax law changed.