Andrew Ross Sorkin of the New York Times has a piece on the proposal to tax the “carried interest” of hedge-fund partners at the rate of ordinary income (right now, 35 percent) instead of at the rate of capital gains (15 percent). I haven’t studied the issue, so I don’t know where I come down on it, but Sorkin, inadvertently, reveals exactly why the current tax system is irretrievably broken. He writes:
Of course, even if the measure passes, Wall Street executives are ready: They’ve already begun devising clever new “structures” to skirt the tax change.
The moment the bill is signed, “the games will begin,” said Francois Hechinger, a tax partner at BDO Seidman who advises venture capital firms. “That’s when people will try to figure out how to get around this.”
If we’ve learned anything from the financial crisis, it seems that new regulations on Wall Street always have a way of breeding another generation of “financial innovation” meant to circumvent them.
Ever since the modern income tax was born in 1913 with an act of Congress 14 pages long, there has been an ongoing evolutionary arms race between the tax collectors and the taxpayers. Every new provision in the tax code begets new means of legally avoiding taxes, which beget new provisions that outlaw the new means, regulate it, or — influenced by lobbyists — even encourage it. The Tax Act of 1942 was 208 pages long. Of those 208 pages, 162 dealt with closing or defining loopholes in earlier acts.
As of 2006, the number of densely printed pages in the tax code was 3,387. The U.S. Code of Federal Regulations dealing with taxes and written by the IRS — in effect, the Talmud to the Torah of the tax code — is 20 volumes, totaling 13,458 pages.
The very, very rich (such as hedge-fund partners) have far more influence in Washington, of course, than the average citizen and are paid attention to by Democrats and Republicans alike. As long as we have a democracy, it will be ever thus. If the taxes on carried interest go up, something else will get them the very rich the hook, just as the nominal 90 percent tax rates of the 1950s were largely negated by a vast number of deductions.
The gathering fiscal problems of the United States will not be solved as long as the current tax code is in place. Unfortunately, among the prime beneficiaries of the current code are the 535 members of Congress, who reap rich harvests of campaign contributions from it.