In 2009, 15% was the average effective tax rate for households making between $75,000 and $100,000, in the middle quintile of U.S. families. That means Mitt Romney, a mega-millionaire, pays the tax rate as if his were a firmly middle class family, which would seem to pose a considerable political problem to a candidate fighting for middle class votes. To be clear, I don't think it's a moral problem. It's not like it's his fault, or anything. It's just the natural outcome of a tax system designed to give special treatment to investors -- and private equity managers, in particular.

Whether investment taxes should be preferential is a matter for debate. You can think of investment income from, say, a company's stock, as being taxed twice: first by the corporate income tax and second by the investment tax. That's a reason for capital gains taxes to be lower, and lower investment taxes theoretically means more savings and investment. On the other hand, the rich are more likely to invest, and if we want to protect a progressive tax code and raise enough money to fulfill our promises, taxing wealthy people's investment income as ordinary income in the 35% bracket would raise money we would otherwise have to borrow or cut.

Either way, private equity's "carried interest" loophole is not capital gains. Capital gains are income from your own investments. Carried interest is income from other people's investments. "If you manage money for a mutual fund or a public company, you pay regular income taxes," James Surowiecki explained in the New Yorker. "Do it for a private fund, and you pay capital gains." That's backward.

But don't expect Romney to hear much about carried interest from his fellow GOP presidential hopefuls. Under chief rival Newt Gingrich's tax plan, all investment income would be tax free and Romney's overall rate would fall quite near to zero.



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*Bonus background from an explainer we wrote last year:

Private equity and hedge fund managers tend to get paid according to what's known as the principle of 2 and 20. They charge 2% annual fees for managing the portfolio of assets, and they collect 20% of the fund's annual profits.

There's nothing strange about this arrangement. It makes sense to align managers' financial interests with their clients'. There is something strange about the way the government taxes these revenue streams. The 2% fees are considered income, so they're taxed up to the 35% marginal rate. The 20% profit returns are considered capital gains, so they're taxed at the long-term capital gains rate of 15%.







