American Jobs Act Designed to Choke Off Job Creation

Earlier we reported that President Obama’s “American Jobs Act” estimated to cost $447 billion in 2012 would, in his words, be “fully paid for” not by actually paying for it with cuts in other spending in 2012, or even with tax increases in 2012.  No, Obama’s “pay for  it” means that over a period of ten years beginning 2013, government will run slightly smaller deficits than now projected for those years.  How would he do that?

His proposed legislation includes “offsets” in the form of tax increases that begin in 2013.  One of the tax increases appears on page 138 of the proposed legislation:

“SEC. 710. SPECIAL RULES FOR PARTNERS PROVIDING INVESTMENT
MANAGEMENT SERVICES TO PARTNERSHIPS…For purposes of this title, in the case of an investment services partnership interest… an amount equal to the net capital gain with respect to such interest for any partnership taxable year shall be treated as ordinary income.

This tedious tax-speak is actually an enormous tax increase on private equity managing partners.  These are people who provide the valuable service to the economy of growing businesses and creating jobs – the very outcome the President claims is the goal of his legislation.  Managing Partners form private equity partnerships to buy and manage businesses on behalf of investors who are called “Limited Partners.”  The goal is to purchase a business and, over a period of several years, increase its value and then sell it. They do this by applying their management expertise to increase sales and profits, making the business more valuable.  This process almost always requires hiring more employees to produce additional products and serve the additional customers.

When the partnership sells the business the difference between the purchase price and the selling price is divided among the Managing and Limited Partners and is taxed as a capital gain.  Capital gains are taxed at the rate of 15% for high income taxpayers and are tax free for low to middle income taxpayers.

Obama’s proposal is to tax the Managing Partner’s portion of the capital gain as ordinary income – in most cases 35%. The change would not affect the Limited Partners whose participation is limited to investing money.

This is an arbitrary attack, a tax increase from 15% to 35% on compensation received by the very people who have the skills and do the actual management work that creates jobs.

Some on the Progressive Left demand an increase in the tax rate on all capital gains, calling the current rate a “loophole for the rich.”  But they either ignore or do not know what history teaches.  There have been many increases and decreases in taxes on capital gains since they began to be taxed in the 1920s.  Lower rates help grow the economy and create jobs by encouraging people whose assets have increased in value to sell those assets and reinvest.  Because there are more asset sales when the tax rate is lower the government actually collects more revenue at the lower rates than it did at higher rates.

Barack Obama himself seems to understand the job creation value of tax relief on capital gains.  Indeed, he proudly takes credit for two capital gains tax cuts right HERE on the White House website.  They include:

  • 75% of any gain from certain small business stocks would be tax free if the stocks were purchased within a certain time period.  (This is effectively a 4% rate on the entire gain.)
  • Zero capital gains on small business investments made during the last two months of 2010

So if a 4% rate or no tax at all on capital gains are good ideas to encourage job creating investments in small businesses why is the less generous 15% rate Managing Partners now pay on all capital gains too low?

There is no answer except the chaotic Obama/Progressive/Keynesian ideology.  He believes liberty is dangerous and ineffective and that government can and should continuously control and manipulate the economy through taxes and regulations.  Progressive S.O.P. is to set tax rates high and then offer discounts for whatever behaviors are in vogue with the elite at the moment.  Today, the most generous tax breaks are tied to investments in “green energy.”

If Barack Obama is successful in imposing higher rates on Managing Partners the entirely predictable result will be far fewer private equity deals, generating fewer gains and less tax revenue to the government.  Even worse, fewer private equity deals mean fewer growing business and less job creation.  It’s likely that by introducing this legislation Obama has already caused pending private equity partnership deals that would have created new jobs to be delayed or even cancelled.  Unfortunately, the government has no process by which to discover, identify and count jobs not created due to business deals not done, because of threatened tax increases or pending government interference via regulation.

2 Comments so far

  1. Drew on September 17th, 2011

    I am a private equity managing partner. This essay pretty much hits the nail on the head. I can offer only two additional insights:

    1. The very essence of investment is risk and reward. If the reward goes down, does anyone think the risks taken will stay the same? Only Progressives, who haven’t made a private equity investment in their lives. This will suck capital out of the entrepreneurial realm.

    2. The standard argument for taxing cap gains or “carried interest” in private equity firms is that its just fee for advice, like a mutual fund advisor. aue contraire. Private equity firms do receive a managment fee for running the limited partnership. And guess what, its taxed as ordinary income – and appropriately so.

    But the business of building a business is quite different. PE principals invest money, sit on the Boards of the companies, find and sell the investments, take on liability, and in general actively participate in the portfolio company’s affairs. Mutual fund manangers do no such thing. Its apples and oranges.

    The Paul Krugman’s and Barack Obama’s of the world know this. But they choose to advocate an investment and job crushing policy for one reason: greed and envy to get tax dollars in their pockets for their own desites.

    Boy are they going to be surprised.

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