Reducing the Deficit: Eliminating Wall Street Loopholes
Monday, September 19, 2011
Mr. President, I want today to discuss two more ways to reduce the budget deficit by eliminating tax loopholes and special tax breaks and restoring fairness to the tax code while protecting essential programs for American families.
Last week, I sent a letter to the members of the Joint Select Committee on Deficit Reduction outlining a seven-point plan that could lower the deficit by $1 trillion over 10 years through some restored revenues. I spoke last week here on the floor about the necessity of addressing revenues, and not just spending cuts, to achieve real deficit reduction. And I discussed in some detail two of the proposals in my plan: combating offshore tax haven abuse and eliminating the tax loophole that forces taxpayers to subsidize stock option compensation for corporate executives.
Since I spoke last week here on the floor, President Obama has outlined his ideas for deficit reduction. Significantly, the President has embraced the need to restore significant revenues to reduce the deficit. I believe the president’s proposals are an important step toward serious deficit reduction. Some of his ideas indeed parallel the proposals I have made to the Joint Select Committee.
Today, I want to describe two more of my proposals, each dealing with a tax loophole that benefits Wall Street at the expense of working families and our fiscal well-being. One would end the “carried interest” loophole that allows hedge fund managers to pay the lower capital gains tax rate on their pay for managing investments. The second would end the “blended rate” loophole that gives preferential status to income from derivatives trading, even in the case of derivatives which are held for just seconds. That preferred status is given over the kinds of long-term investments that are more important in helping put capital to work growing the economy and creating jobs.
Each of these loopholes amounts to a subsidy. Working American families who pay their taxes every year end up carrying an extra burden because these provisions allow Wall Street to pay a lower tax rate than the rate applied to average workers. I cannot see how anybody can explain to working Americans that they must bear a greater tax burden so that hedge fund managers get a tax break on pay that often amounts to millions of dollars a year, or so that speculative traders can pay a lower tax rate on so-called investments they might hold for just a few seconds.
Let’s first talk about the carried-interest loophole. Hedge fund managers generally make their money by charging their clients two fees. First, the manager gets a management fee, typically 2 percent of the assets. Second, the manager typically gets 20 percent of the profits from those investments above a certain level. That 20 percent is known as “carried interest,” and under current law, hedge fund managers can treat that income as a long-term capital gain, taxed at a maximum rate of 15 percent, and not at higher ordinary-income rates.
And what is the blended-rate loophole? Since 1981, those who trade in some financial products, such as futures contracts and options, have enjoyed a specially created tax loophole that allows them to pay a lower rate than, for example, traders who buy and sell stock. No matter how long a speculator holds on to a futures or options contract – again, even if it’s a few seconds –their gains and losses are taxed at a lower, so-called “blended” rate, that is, part at the capital gains rate, part as ordinary income. So a dealer who buys a stock, and sells it within a year, must pay taxes at the ordinary income rate, while the same dealer who buys an option and sells it 30 seconds later gets to pay the lower capital gains rate on most of that income.
These special tax breaks impose an unfair burden on American taxpayers, and they contribute significantly to the budget deficit. Based on estimates from the Joint Committee on Taxation, eliminating the carried interest loophole could reduce the deficit by $20 billion or more over 10 years. That joint committee has made no estimates of the cost to the Treasury of the blended-rate loophole, but it is reasonable to assume that ending it would reduce the deficit by billions of dollars.
But beyond their fiscal impact, these proposals would help restore fairness to the tax code. These tax subsidies give preference to activities that do not contribute much to economic growth or job creation the way that other activities that don’t enjoy the same subsidies do. Instead, they subsidize hedge fund managers and derivatives traders.
Take the carried-interest loophole. We tax income that investors receive from hedge funds and other investments at the lower capital-gains rate because, in theory at least, those investments help put capital to work, creating jobs and growing the economy. But the fund manager isn’t putting his own capital at risk. He’s just doing his job – the same as his employees, or the janitor who cleans his office at night. This tax break doesn’t reward risk-taking or job creation. It rewards what is already an extremely lucrative profession. According to a survey by a magazine covering the hedge fund industry, the top 10 hedge fund managers last year each made at least $440 million. Six made more than $1 billion, in one year. It’s hard to imagine we need to offer a tax break to encourage people to become hedge fund managers.
Similarly, the derivatives blended-rate loophole doesn’t just add to the deficit. It’s plainly unfair. It’s unfair not only to working Americans who have to pay higher tax rates than these derivatives traders. It’s also unfair to investors who risk their capital in long-term stock and other investments that are more important to job creation, but don’t enjoy that same tax break. This loophole gives preferential treatment to short-term speculative trades over long-term patient capital, and that’s exactly the wrong message to send.
We should end these Wall Street loopholes, and I have encouraged the members of the Joint Select Committee to end them. We should end them because they add to the deficit, because they subsidize activity that does not need a subsidy and that does not add much to economic growth, and because they are unfair to the millions of American taxpayers who do not enjoy the same tax breaks and have to pay more in taxes to make up for these unfair subsidies. Eliminating them would be good for our economy. It would reduce the deficit by billions of dollars a year. It would help to fund important programs that protect seniors and children, programs that make our nation stronger.
I hope the Joint Select Committee will look hard at these and the other proposals in my plan as they carry out their difficult task. And I will be back again in the next few days to discuss three more ideas that can reduce the deficit, protect the middle-class and avoid draconian cuts in vital programs.