I am the co-host of a nationally syndicated show that specializes in helping entrepreneurs start new businesses, as well as run their businesses. The show is called “Recalculating,” and on the show, we answer all kinds of economic questions and do interviews with people of some particular expertise. Our goal is to try and help people realize the American dream of owning their own business.
Several months ago we had another talk show that was political in nature, but after the presidential election, we anticipated there could be a new economic boom opportunity for small business people under a Trump Presidency, and thus we changed our show. I think our premise is still right and the pending tax bill will have a significant impact on how big the opportunity will be for small business.
It’s hard to say what tax reform will, in fact, look like, but one thing is clear: the risks in starting a new business, even under President Trump’s tax plan, may never have been higher. Just in the last few days the former chairman of the Federal Reserve, Ben Bernanke, was quoted as saying that he expects economic returns to be lower going forward.
We could do a whole series of articles on the implications of lower overall returns, but that is for another time. Instead, the need for tax reform concerning capital gains is paramount.
Despite President Trump’s push to reform our tax system and reduce the tax burden on individuals and companies, the Bernie Sanders/Elizabeth Warren wing of the Democratic Party still dictates economic policy, as evidenced by a recent press conference on Capitol Hill. In November 2016 Sanders and Warren were made chair and vice chair, respectively, of the Steering and Outreach Committee, which sets the Democratic Party agenda in the Senate.
Along with Sanders/Warren, a group formed in the last few months has demanded that any reform measure includes a change in carried interest taxes. This group includes long-time big taxer Senator Tammy Baldwin (D-WI) and U.S. Representative Sander Levin (D-MI). They have joined with members of the so-called “Patriotic Millionaires,” a group of 200 wealthy Americans that want to ensure millionaires; billionaires and corporations pay their fair share of taxes. Also in this group is a big union boss, Randi Weingarten, president of the American Federation of Teachers. Such a reform changes the tax rate makes a great talking point on the campaign trail, but it will hurt retirees, seniors, pensioners and small businesses.
What is “carried interest” and why are liberals trying so desperately to increase the tax rates? The US Tax Code has historically taxed capital gains at a lower rate than ordinary income taxes. By lowering the tax rates the Government created incentives for people to take risks, in turn that was beneficial for the American people and our economy. George H. W. Bush in the late 1980s was part of a bipartisan push to reduce the capital gains tax rate to help create jobs, prosperity and growth. Today, the Democrats want ordinary income and carried interest to be taxed at the same ordinary income rate.
The stalking horse for that effort is “carried interest.” When a partnership is created for a business or real estate investment, all of the cash/flow earned from this long-term investment is treated as a capital gain. The liberal left likes to portend that carried interest is a shady loophole, but in truth it is an investment idea that goes back to the Middle Ages. In practical terms, an increase in the tax on carried interest transactions is an increase in the capital gains tax rate.
The result? Partnerships, real estate trusts, pension funds, retirement plans and small businesses would all face higher taxes and fees, which would be paid for by investors, retirees and senior citizens. In short, the Democrats want to tax risk-taking.
Keep in mind that if the present anticipated return on investment is expected to diminish, then the risk to the investor dramatically increases. Despite this assessment, America needs to start up new businesses and in turn, needs to have investors willing to take the risk on something new and unproven. There is no doubt that thousands, if not tens of thousands of entrepreneurs, are working in their garages into the wee hours of the night coming up with the next widget.
Just because they can build it, though, doesn’t mean that people will be racing to buy this widget. The entrepreneur may invest every last cent of his or her money into his or her dream. But if the business is going to get off the ground and have any chance of success, it needs investors willing to take a chance and to risk substantial amounts, even if the venture doesn’t succeed.
The SBA estimates that five out of 10 businesses started now will not be in business five years from now. We could list many reasons why businesses fail, but this commentary is about risk and reward. Based on the SBA numbers, 50% of the time you are losing money, and maybe all the money in your investment. Thus, given the tax reform issues under discussion, how should carried interest be taxed?
The left thinks that carried interest is a tax loophole and should be taxed as ordinary income and not at the capital gains tax rate. The reason why the tax rates are different between capital gains and ordinary income is because the government wants people to take a risk. The government is willing to give those people who have the money and take a risk a preferential tax treatment. It is through risk that new businesses are formed, new products and services are developed, and people are put to work.
If investors in America see a significant change in the tax law so that investments of time, talent, and treasure will be taxed the same as ordinary income, they will look elsewhere to invest their money. The Trump administration is trying to find ways to entice corporations to bring back to America trillions of dollars earned overseas and retained there legally. Tim Cook of Apple said in his quarterly earnings report to shareholders that Apple has almost one-quarter of $1 trillion in cash overseas and with a favorable tax rate, he would bring it back and share it with shareholders, as well as expand Apple’s operations in the United States.
If America’s economy is going to grow, we need people willing to take risks and to be treated fairly under the tax code for the risk that they are taking. Fair treatment of investors willing to take risks will grow America. The real question we must ask is: do the millennia’s want to become rich or just collect dividends? If the tax code is going to treat risk-taking the same as dividends, investors will not want to be risk takers. The idea put forth by the group that includes Baldwin/Levin and the Patriotic Millionaires should be rejected.