House Democrats keep stepping on President Obama's applause lines about innovation and job creation. On Tuesday, Mr. Obama announced that "we're proposing a complete elimination of capital gains taxes on small business investment" for one year.
Responding with rare dispatch, the House voted yesterday to change the capital gains rate for venture capitalists who invest in technology start-ups. But rather than eliminating the tax, the House more than doubled it, moving the tax rate to 35% from 15% by reclassifying such gains as ordinary income.
Private equity fund managers and managers of real-estate and oil-and-gas partnerships would also get socked with this 133% tax-rate increase. Now there's a way to encourage economic growth and new jobs.
If Mr. Obama is upset that he didn't have more of a chance to discuss this before the House acted, he's not alone. Knowing how popular tax increases are with unemployment at 10%, the House majority rushed the bill to the floor without a hearing or even a committee vote. Then they buried it in a package advertised as an extension of tax cuts for research and development.
The new 35% rate applies to what is known as "carried interest," which is income that only materializes if fund managers wisely invest the fund's capital and only after other investors in the fund have benefited. Venture and private equity fund managers already pay normal income taxes on their regular salary derived from management fees. The carried interest, no sure thing, represents a capital gain on a successful investment and has therefore been taxed that way.
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My understanding is that the term "carried interest" does *not* apply to the VC's own direct investment in a venture. For example, say the VC puts $1 million of his own funds into a company but also puts $10 million of limited partner money into it. The carried interest is basically a commission that he gets on any increase in value of the LP-investor money. His own direct investment is still taxed at capital gain rates.
The carried-interest tax increase is still probably a bad idea, but unless I'm wrong here it is not the same as a tax increase on actual capital gains.
Thanks David for pointing that out. I fixed the error. Yeah, it's still a bad idea. What's the difference between the 90's and the 2000's in term of the economy? The growth in the 90's came from the Internet boom which helped create efficiencies on an economy wide scale. Clearly we would be better off with new industries helping to create real economic growth, which is something we cant do without VC's. It really seems like the Democrats have no understanding of incentives.
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