The mercenary qualities of liberal economists

Here is Mankiw circa 2007:

Thursday, July 19, 2007

The Taxation of Carried Interest

Several people have asked me my views on the taxation of carried interest. It is a complicated issue, and I don’t pretend to be an expert on tax law, but here goes.

Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such. Paul Krugman hit the nail on the head with this question:

why does Henry Kravis pay a lower tax rate on his management fees than I pay on my book royalties?

The analogy is a good one. In both cases, a person (investment manager, author) is putting in effort today for a risky return at some point in the future. The tax treatment should be the same in the two cases.

One hedge fund manager told me that the initial value of the carried interest should be taxed as ordinary income and then the subsequent returns should be taxed at the capital gains rate. Maybe so, but taxing the terminal value as ordinary income (as is being proposed) seems strictly better for the manager in present value. It is as if the manager put the initial value of the carried interest in a tax-deductible IRA, deferring tax on this compensation until the money is withdrawn at a later date. The proposed reform, therefore, does not seem excessive.

John Berry’s recent article on carried interest suggests that the Bush administration is opposed to reform. If so, I fear the administration is on the wrong side of the issue.

Update: The FT reaches the same conclusion.

Here is Mankiw Circa 2012 after a series of lengthy contortions:

Capital Gains, Ordinary Income and Shades of Gray

Critics of current law think it is unfair that these private equity partners are taxed at capital gains rates, whereas other high-income individuals like doctors and lawyers pay the much higher tax rates for ordinary income. It is a reasonable point, and some reform may well be appropriate. But as the tax situations of Abe through Earl illustrate, it is not obvious what the best approach would be. Not all problems have easy answers.

How to resolve the puzzle? As per Wiki

From 2003 to 2005, Mankiw was one of President George W. Bush‘s top economic advisers, and was chairman of the national Council of Economic Advisers (CEA). In November 2006, Mankiw became an official economic adviser to then-Massachusetts governor Mitt Romney‘s political action committee, Commonwealth PAC.[15] In 2007, he signed on as an economic adviser to Romney’s presidential campaign.[16]

Mitt Romney on capital gains and carried interest:

So Mitt needed obfuscation and it appears Mankiw delivered.

Now, ask me if I am shocked or outraged?  Nope, not in the least.  Economics is after all a social science.

HT Econospeak

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