For the Wealthy, a Taxing New Worry
Tax law professors don’t normally have much of a public profile. Victor Fleischer does. In fact, one business journalist has just tagged this ace analyst from the University of San Diego “the closest thing the tax world has to a rock star.”
Most rock stars have big break-out hits. Fleischer’s big break-out came about a decade ago when his scholarship exposed an incredibly lucrative tax giveaway to the rich that hardly anyone knew existed. The “carried interest” loophole, Fleischer detailed, was helping private equity and hedge fund billionaires chop their tax bills by nearly half.
Thanks largely to Fleischer, this preferential tax treatment of “carried interest” has now become the single most notorious loophole in the federal tax code. But the carried interest tax break — a giveaway that’s saving America’s financial industry heavyweights an estimated $18 billion a year — has survived this notoriety. Congress has still never come close to repealing it.
That may be about to change. At least some lawmakers are showing signs they’re really ready to take Big Finance on. The clearest sign of all: Sen. Ron Wyden, the Oregon Democrat who’ll chair the Senate Finance Committee if Republicans lose their Senate majority this November, has just hired Victor Fleischer as his co-chief tax counsel.
Most all the commentary around this surprise hire has so far — and understandably — revolved around the future of the carried interest loophole. But Fleischer, we need to keep in mind, has never been a one-trick pony. He has his eyes on rich people-friendly tax loopholes that go way beyond carried interest.
One of these loopholes just happens to be more obscure than carried interest used to be — and much more lucrative for America’s super rich. Meet the federal tax code’s preferential tax treatment of “founders’ stock.”
Most of America’s superest rich owe their exceedingly good fortune in life to the companies they founded. And most of these founders owe the immensity of their good fortune to the wink-wink the tax code extends them at tax time.
Overall, Fleischer calculates, this winking drains more out of the federal treasury than the carried interest loophole. Yet the founders’ stock loophole continues to operate almost totally under the radar.
Why the indifference? Founders’ stock, for starters, involves all sorts of impenetrably complicated tax concepts, everything from “the time value of money” and “remittance obligations” to the “lock-in effect” of the “realization doctrine.”
The carried interest story, by contrast, remains easy to tell: Private equity kingpins raise funds from investors to buy and sell companies. They typically keep for themselves 20 percent of the profits from all their wheeling and dealing.
This 20 percent clearly represents payment for services rendered and ought to be taxed no differently than a commission an auto salesperson makes. But the carried interest loophole lets private equity movers and shakers claim this income as a capital gain, a label that saves them about $160,000 in taxes on every $1 million they rack up.
The unfairness — and outrageousness — of this special treatment could hardly be easier to understand.
Strip away the conceptual underbrush around taxing founders’ stock and much the same dynamic emerges: Extremely rich people get to avoid paying standard tax rates on the vast bulk of their income.
Consider two software hotshots with an idea for the next super-hot high-tech thing. They take their know-how to a venture capital company. The venture capitalists — the VCs — like the idea and pump operating cash into it. In return for the cash, the VCs get stock in the fledgling new company.
The software hotshots — the “founders” — get stock, too, as payment for their expertise and labor. This stock could eventually have extraordinary value. But the current tax code essentially lets the founders sidestep paying any meaningful tax on it.
“The tax treatment of founders’ stock,” notes Fleischer, “represents a critical design flaw in a progressive income tax system” that “contributes to the broader trend of increasing inequality, particularly at the very top of the scale.”
Fleischer sees the current tax preference for founders’ stock as part of an even bigger political and cultural problem: America’s over-the-top genuflecting before entrepreneurial “genius.”
This genuflecting has translated into a wide variety of special tax breaks for entrepreneurs, with the preferential treatment of founders’ stock only one among them. The justification for all these tax breaks? Tax breaks for entrepreneurs, we’re assured, “create jobs and fuel economic growth.”
But researchers have found next to no evidence that tax breaks for entrepreneurs advance either of these goals, as Fleischer points out in an insightful — and entertaining — paper that appeared this past spring in the Fordham Law Review.
“Tax breaks mostly reward entrepreneurs for activity they would have engaged in anyway,” he points out.
What about the argument that we as a society have to be willing to reward entrepreneurs for the risks they take? Lots of Americans, observes Fleischer, take risks — and get no tax breaks for their risk taking.
“It is not self-evident,” he writes, “why risk taking by rich executives and venture capitalists is more valuable than risk taking by, say, a Korean-American grocer, a Mexican-American restaurateur, a farmer in California, or an Uber driver in Miami.”
“The current tax code,” Fleischer sums up, “has become an echo chamber for the economic forces driving the increase in income and wealth inequality, the blurring of economic and political influence, and the degradation of paid work.”
Welcome to Capitol Hill, Victor Fleischer. We need you there.
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This was reposted from the CAF.
