One Blow for Income Equity

by John Lawrence

An article in the May 8th New York Times lays out a golden messaging and policy opportunity for President Obama and congressional Democrats, a huge home run that can trump Trump and expose Paul Ryan and the Republican party in general as the clueless guardians of the one-tenth of one percent.

As campaign strategists know and Donald Trump has just demonstrated with disturbing effectiveness, messaging is key to political success. The simpler the message, the more easily it is disseminated, and the more often it is repeated correlate with precise accuracy the likely impact.

So far this political season, the effective message has been the unresponsiveness of elected officials to the economic plight of the average American. The candidate and party who can translate concern about the maldistribution of wealth into genuine policy results is going to get a leg up over the next few months.

Now, unfortunately, the details of this proposed message are a bit convoluted, especially if you talk to a tax attorney or CPA; so don’t. Here are the basics. Provisions of the tax code, or tax regulations (which one is actually critical to the outcome) let a tiny fraction of Americans – not the top ten percent or the top one percent that Bernie Sanders rails about, but rather the top one-tenth of one percent (the percent to which Donald Trump belongs) to camouflage the bulk of their sizable annual income as “capital gains” instead of “income” and, in doing so, cut their tax rate in half. And when you shelter the taxes of those folks, that’s a whole bunch of money that goes to promoting income inequality.

Since 2009, President Obama has proposed reforming this “carried interest” provision, but the failure of Congress to pass comprehensive tax reform has left the provision in place, and billions continue to flow into those privileged pockets. Congressional Democratic leaders for the most part are on board with the change (a few Democratic outliers are wary of offending Wall Street buddies), but without Republicans moving along a tax bill, they have no vehicle to force a vote on ending the carried interest loophole.

But there might be another way for Democrats to seize the issue of tax reform and actually strike a blow for greater income equity. Several tax scholars and practitioners argue there is no need to wait for comprehensive tax reform.  Instead, these experts argue, the President could direct Treasury Secretary Jack Lew and the Internal Revenue Service to issue regulations revising how carried interest is taxed, closing the loophole, gaining tens of billions of dollars to help reduce the deficit, and impacting only the swell folks with the big homes, private jets and humongous trusts.

Since the 2012 election, many Democrats have been encouraging Obama to crank out more Executive Orders to effectuate policies that Congress will not debate, let alone legislate.   And while it pains the heart of those who have invested decades in rebuilding Congress as a co-equal branch of government, there is little alternative to policy stasis if Congress is unable, or unwilling, to perform its constitutional responsibilities as has largely been the case since 2011. The fact that many Republicans are delighted with inaction and untroubled by the injurious impact such inactivity has on the reputation of government is irrelevant: when one branch of government shuts down, it should be no surprise that other branches move to take up the slack.

So Obama has been issuing Executive Orders on a wide range of subjects from marriage equality to the minimum wage to immigration. Not long ago, Treasury Department issued welcome rules to prevent U.S. companies from relocating their corporate headquarters (wink, wink) overseas to circumvent American corporate taxes. Now, according to some tax specialists, Obama could do the same with carried interest.

According to Alan J. Wilensky, a former deputy assistant Treasury secretary, changing the carried interest “is something President Obama can do and should do,” an opinion shared by other tax experts. According to Victor Fleischer, a University of San Diego law professor, Congress in 1984 not only intended that hedge fund managers pay income taxes on their earnings, but gave Treasury “broad discretion” to require them to do so. Flesicher estimates closing the loophole could save $180 billion (with a “b”) over the ten year budget window that Congress uses; the Congressional Budget Office says the number is closer to $18 billion.

From my experience, CBO is probably closer to the truth, but why leave even $18 billion waiting on the table awaiting “comprehensive tax reform,” especially since that legislation — whenever it ultimately emerges — undoubtedly will confer addition benefits on the same class of ultra-affluent Americans?

Voters are crying out for somebody to do something that demonstrates  concern about their top issue: economic security. (There is considerable evidence that is the #2 and #3 issue as well.) Closing the carried interest loophole does not exactly require a profile in courage: even Donald Trump admits it is a wasteful abomination. In fact, so few people even bother to justify it that failure to shut it conveys far more political risk than actually doing so.

Acting unilaterally on carried interest might upset some green eyeshade-wearing purists who think major changes in the code should only occur in conjunction with comprehensive tax reform. But there isn’t going to be tax reform, comprehensive or otherwise, between now and Election Day, as Speaker Ryan (the former Ways and Means chairman) has already admitted. So why not act unilaterally to close a loophole, raise a few billion a year and strike a blow for income equity all without hurting 99.9% of the population?

Naturally, the lawyers will caution against such a move by the President, warning that the courts might step in and rule his action an overstep. Well, the courts have done that on other orders, specifically, his immigration directives, but that possibility did not slow down the President. Others may argue acting on carried interest will angry up the Republicans whom we will need on other issues. Right. Like they could be less interested in being cooperative. In fact, far better to take away one GOP chip in future tax negotiations, if and when they ever occur: “You get nothing for ending carried interest because … it doesn’t exist anymore.” Some may complain that, combined with ending the Bush upper income tax cut in 2013, Democrats will look like we are always going after the fat cats. Well, as Willie Sutton used to say when asked why he robbed banks, “That’s where the money is.”

Congressional Democrats should unite behind an effort to close the carried interest loophole: call it “End the $180 billion loophole for the .1%” or something a little more chant-able. Pressure, or encourage, President Obama to take the plunge, now, not a few weeks before Election Day when no one knows it happened, and then message like crazy the blow that was struck to end income inequity. It’s been the party line for 7 years: now, do it! Get carried away.