Congress Eyes Hedge-Fund Tax Loophole

A couple of weeks ago, the New York Times ran an editorial excoriating the way in which private-equity billionaires pay lower tax rates than working stiffs. The leader was based on a paper by Victor Fleischer, who explains the loophole in great detail: in a nutshell, income can very easily be converted into something called "carry", which is treated as capital gains for tax purposes.

Today, the other shoe drops, thanks to Jenny Anderson, again in the NYT. While US savers are generally allowed to save no more than $20,000 tax-free per year, she says, hedge-fund managers can keep tens or hundreds of millions of dollars in income without paying any tax on it for years. The trick is to keep it in an offshore fund, and pay tax only when the money is finally repatriated:

A hedge fund manager makes $10 million in fees and defers it for five years, earning a return of 10 percent a year. When he pays taxes at the end, he walks away with $10.5 million. Another manager who makes the same $10 million pays his taxes immediately. He still earns 10 percent on what’s left, but over the same period he accumulates just $8.9 million.

Remember that Americans pay tax on their global income: just because they're technically earning this money offshore doesn't mean they shouldn't pay tax on it.

Given the manner in which private-equity principals and hedge-fund managers are becoming elided in the public eye, there's a good chance that if Congress attacks either of these tax breaks, it will attack both of them. Which will be easy money for the US fisc.