Teachers and hedge funds

Hillary Clinton: “Top hedge fund managers make more than all kindergarten teachers combined.”  That’s quite true, but what does it mean to teachers or anyone else?

In simple terms, which I am only capable of on this topic, a hedge fund takes other people’s money, lots of it, and invests it with the goal of beating the stock market performance. For this privledge the investors pay a set fee and the fund takes about 20% of the profits it generates. So, if you give a fund $100 million, you pay a 2% fee or $2,000,000. If the fund grows your money to $150,000,000, you get to keep 80% of the gain or $40 million. The fund in this simple example makes $12 million less its expenses and in some manner the fund managers divide up the profits.  

Instead of $100 million make that $10 billion invested and you can see the payoff can be quite large (and so can the losses).  

The 20% of the profits I refer to is also called carried interest. Much of the flap over hedge funds and their managers income centers on the tax rate for the 20% as explained below. In my example above, the $10 million in carried interest (ignoring expenses for the moment) would pay $2,380,000 in taxes. If the same profit were taxed as ordinary income the tax would be $4,250,000. 

So what does all this have to do with what teachers earn? Absolutely nothing!  These guys are making or losing money by playing the stock market just like you do in your 401k plan … we’ll sort of anyway. 

What Old Hillary was really saying is “These poor fools don’t understand this stuff and it sounds good enough to stoke them with envy. Then I’ll hit them with the fair share bit.”

Now you may be saying to yourself, why should this profit be taxed at dividend and capital gains rates? Well, it is mostly generated by the growth in investments and as such is taxed the same way you would be taxed on dividends and if you made a profit by selling stock.  Does the fact we are talking about billions of dollars as opposed to perhaps a few hundred make a difference? 

Does it matter that the fund and not the individuals actually earned the money?  Perhaps?

Is it fair that your gains within your 403b, 401k or IRA are taxed as ordinary income while hedge fund gains are taxed at 20%? Maybe not. 

Do all the investment benefits of the tax code go to the wealthy? Not exactly, average Americans can either save on a tax-deferred basis or they can use a Roth 401k or IRA and all their accumulated earnings will be tax-free.  Also, one of the biggest tax advantages many average people have is the tax-free value of employer paid health insurance. 

The fact is nothing is as simple as simple-minded, opportunist politicians make it sound with their populist rhetoric. Don’t drink the coolaid before thinking this stuff through. 

And speaking of simple-minded and fair share, let’s give Old Bernie a shout out. 

From The Hill.com

Sen. Bernie Sanders (I-Vt.) wants to increase the estate tax for wealthy Americans and close tax loopholes, which he says will help bridge the country’s wealth gap.

Sanders, who is seeking the Democratic presidential nomination, introduced legislation that would require anyone who inherits more than $3.5 million to pay an estate tax, sometimes referred to by opponents as the “death tax.”

He would also increase tax rates so anyone who inherits an estate or assets worth between $3.5 million and $10 million faces a 45 percent tax rate; anyone who inherits an estate worth between $10 million and $50 million faces a 50 percent tax rate, and anyone who inherits an estate worth more than $50 million faces a 55 percent tax rate.

Under current law, a deceased person’s estate or assets have to be worth more than $5.43 million before they are subject to the tax. Currently, the top estate tax rate is 40 percent.

Sanders said under his plan, 99.75 percent of Americans wouldn’t pay more in estate taxes.

“Our nation cannot survive morally or economically when so few have so much while so many have so little,” Sanders said. “We need a tax system which asks the billionaire class to pay its fair share of taxes and which reduces the obscene degree of wealth inequality in America.”

So, now the person who works hard, maybe builds a small business, carries life insurance and owns an appreciated home is the billionaire class? What is fair about taxing the same money multiple times? What is fair about confiscatory taxes even if it only affects a small percentage of Americans? 

Now our goal in America is to reduce inequality by overtaxing a few people? Exactly how does that work? Does the top 2% of earners pay not 36% of all income taxes as they do now, but 60%, 80%, 90%? Is that how we define fair? 

If you buy into this socialist rhetoric, exactly how do you think these taxes would make your life better, give you a raise, create more opportunity for you? Or does sticking it to the more successful among us just make you feel good? 

The fact is that these kinds of taxes won’t even dent the current annual deficit let alone provide money for more spending. The fact is that to fulfill all the promises of “free” and “affordable” stuff (Social Security, Medicare, Obamacare, “free” college, “free day care”, etc) requires higher and higher taxes on everyone

People get comfortable with all the great promises, except when it comes to paying for them with their money. Look at Greece, generous government pensions starting at an early age while Greece has the worst tax collection record around. Nobody wants to pay. 

The irony of Old Bernie’s strategy is that the very wealthiest among us will not pay more in taxes, but rather will give the bulk of their money to charity as several have already pledged to do. 

From taxpolicycenter.org

What is carried interest and how should it be taxed?

Carried interest is a right that entitles the general partner (GP) of a private investment fund to a share of the fund’s profits.  Typically, for a private equity or hedge fund, the GP is itself a partnership that is owned by investment managers and contributes 1 to 5 percent of the fund’s initial capital and commits to managing the fund’s assets. In exchange, the GP receives an annual management fee of 2 percent of the fund’s assets plus a “carried interest” of 20 percent of the fund’s profits that exceed a certain “hurdle” rate of return. The individual partners of the GP, not the GP itself, are taxed on these payments. (In some cases, the general partner may make larger initial capital contributions or assume capital risks prior to the formation of the partnership; this is particularly true for real estate and energy partnerships.)

Carried interest constitutes on average about one-third of the payments that private equity GPs receive, and the management fee the remainder. Under current law, the management fee is taxed like wage and salary income, with a top income tax rate of 39.6 percent plus 2.9 percent in Medicare taxes, whereas the carried interest is taxed as investment profit, which often faces a lower tax rate. In particular, any portion of the carried interest that represents qualified dividends or long-term capital gains of the fund is taxed at a top rate of 20 percent plus a 3.8 percent surtax. Many commentators believe it would be fairer and more efficient for carried interest to be taxed like wage and salary income, but others disagree.

3 comments

  1. Bernie essentially suggests you should spend it all while you are alive – if the only other choice is to give it to government hacks who will redistribute it to others.

    Similarly, Bernie essentially also suggests that if you aren’t going to be a multi-millionaire, better to spend it all (plus maybe another 50%) while you are alive, so you have no assets in retirement and can qualify for Medicaid, Supplemental Security Income, etc.

    These folks really believe in this stuff – if only as a means of buying votes. We are only a few steps away from a newer form of “Grecian formula”.

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    1. What is really scary are the number of average people who just lap this stuff up without the slightest question of how it works. And the press is just as bad, maybe worse because they promote it without question.

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  2. I wish these people would just call it what it is. Robbing the rich to give to people who think they are poor because these people are being told that they are poor. What they should be telling them is that they can take advantage of paying lower tax rates by investing in the stock market long term and paying capital gain tax rates of 15% verse normal income tax rates that are much higher. The trick here is having a trusted advisor who will tell you when to stop taking the tax shelter of your 401K, IRA, etc and just plain invest in the market and to do this you need a really good crystal ball to figure out where you will be in 20 or 40 years.

    In my case I could not have saved as much as I did without the tax advantage of pre-tax dollars going into my 401K. I doubt I would have started a Roth IRA and a family at the same time if it was offered back then. Either way they should being telling them “look at the tax break we already gave you and you are not taking advantage of it” instead of hey dumb American, you keep paying your high taxes and I promise to tax these rich guys even more.

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