Hey, Atrios

From Eschaton:

I'll admit that, for the most part, during the great and glorious benevolent rule of the Kenyan Muslim Socialist, I've been a bit unsure just what I should be advocating for. 

I've found my groove. We need to increase Social Security Benefits. The Professional Left needs to sign on to this. All the oldsters need to vote for it. Congressional candidates need to get on board.

From How to Save America in Several Easy Steps, last November:

But what is we weren’t satisfied with saving Social Security. What if we … wanted to make it better.

Consider that CNN has recently reported that:

A quarter of middle-class Americans are now so pessimistic about their savings that they are planning to delay retirement until they are at least 80 years old -- two years longer than the average person is even expected to live.  

It sounds depressing, but for many it's a necessity. On average, Americans have only saved a mere 7% of the retirement nest egg they were hoping to build, according to Wells Fargo's latest retirement survey that polled 1,500 middle-class Americans. 

While respondents (whose ages ranged from 20 to 80) had median savings of only $25,000, their median retirement savings goal was $350,000. And 30% of people in their 60s -- right around the traditional retirement age of 65 -- that were surveyed had saved less than $25,000 for retirement.

For whole lot of folk, the economic stagnation, combined with the downturn in the housing market, means that retirement is looking harder and harder to achieve. Here’s the chart for the S&P 500 for the last twenty years.

Ah, the Clinton years; they were so good to us. Unfortunately, we’ve not been able to get back to those heights – even though eleven years have passed. So if you had a retirement fund keyed solely to the S&P 500 (and which included neither dividends nor additional capital contribution), your performance would be as shown below.

Since January 1, 2000, you would have experienced a negative return of $179, or about -13% over almost eleven years. That is not how to build a retirement plan.

But, perhaps you’ve got money stuck in your house, and were hoping that would play a key part in your retirement.

According to the Case-Shiler Home Price Indices, your house is now worth what it was eight years ago, in 2003.

Now the loss of a decade’s worth of growth it not something which remedied easily, or even with a lot of work. But we can do something for those people who planning to work for years after they die.

The magic words are “unearned income.” The 1% have pulled off a brilliant con over last 30 years, where they’ve been able to convince the government that unearned income – the kind that comes from capital gains, dividends and interest – should not be subject to the kind of taxation that the rest of us face. In terms of income tax, long term capital gains are taxed at 15%, far below the current maximum marginal rate of 35%.

But it gets worse in terms of Social Security, because these things have ... never been taxed at all.

In 2009, the IRS reported that there was nearly $7.7 trillion in income, $5.7 of which was salaries and wages. Now, just because something isn't salaries and wages does not necessarily mean it would qualify as "unearned income," but it does give us a sense of scale. If only half of it was -- $1 trillion -- then applying the 2009 employee Social Security rate of 6.2% would yield an additional $60.2 billion in revenue.

And all of this increase would be on income -- literally -- that no one worked for.

Fixing Social Security is easy -- just get rid of one tax break for wealthy (and well-off). Making Social Security better will take more work, but it's the kind of thing a decent country -- one which doesn't make dead people work -- should consider. And one good place to start would be re-examining the special treatment we give to "unearned income," a.k.a. money no one worked for.

Why Inequality Matters in a Recession

Joseph Stiglitz, writing in the New York Times:

There are four major reasons inequality is squelching our recovery. The most immediate is that our middle class is too weak to support the consumer spending that has historically driven our economic growth. While the top 1 percent of income earners took home 93 percent of the growth in incomes in 2010, the households in the middle — who are most likely to spend their incomes rather than save them and who are, in a sense, the true job creators — have lower household incomes, adjusted for inflation, than they did in 1996. The growth in the decade before the crisis was unsustainable — it was reliant on the bottom 80 percent consuming about 110 percent of their income. 

Second, the hollowing out of the middle class since the 1970s, a phenomenon interrupted only briefly in the 1990s, means that they are unable to invest in their future, by educating themselves and their children and by starting or improving businesses. 

Third, the weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks. The recent modest agreement to restore Clinton-level marginal income-tax rates for individuals making more than $400,000 and households making more than $450,000 did nothing to change this. Returns from Wall Street speculation are taxed at a far lower rate than other forms of income. Low tax receipts mean that the government cannot make the vital investments in infrastructure, education, research and health that are crucial for restoring long-term economic strength. 

Fourth, inequality is associated with more frequent and more severe boom-and-bust cycles that make our economy more volatile and vulnerable. Though inequality did not directly cause the crisis, it is no coincidence that the 1920s — the last time inequality of income and wealth in the United States was so high — ended with the Great Crash and the Depression. The International Monetary Fund has noted the systematic relationship between economic instability and economic inequality, but American leaders haven’t absorbed the lesson. 

Our skyrocketing inequality — so contrary to our meritocratic ideal of America as a place where anyone with hard work and talent can “make it” — means that those who are born to parents of limited means are likely never to live up to their potential. Children in other rich countries like Canada, France, Germany and Sweden have a better chance of doing better than their parents did than American kids have. More than a fifth of our children live in poverty — the second worst of all the advanced economies, putting us behind countries like Bulgaria, Latvia and Greece. 

From the Atlantic.

The 47% and the Flat Tax That's Already Here

The conservative wet dream is a flat tax. Cain, Gingrich and Perry endorsed it in the primaries, as it tackles two problems at once: it lowers taxes on the rich, and it gets the 47% to pay up.

Sadly, it's already here. (Click to embiggen.)

As The Atlantic's Matthew O'Brien points out:

We barely have a progressive tax system. People basically pay what they earn -- even the top 1 percent.  (Emphasis added).

So how does this square with Romney's indictment of 47% of America?

Well, there are lots of other taxes, and they're mostly regressive. The payroll tax and state and local taxes all hit poorer households harder than they hit richer households.

In fact:

Once you add up the progressive federal income tax and the regressive federal payroll tax -- which raise roughly the same amount of revenue -- with regressive state and local taxes, you only just get a progressive system overall.

As this graph from the Tax Policy Center shows, payroll taxes made up 40% of federal tax revenue, as opposed to 42% for the individual income tax. Corporate income tax, meanwhile, made up only a meager 9%.

And, just for fun, the amount of taxes paid by corporations has been on the decline for decades.

Revenue from the corporate income tax fell from between 5 and 6 percent of GDP in the early 1950s to 1.3 percent of GDP in 2010.

That's a drop of between somewhere around 75 - 80%. If you're looking for a reason why the deficit's been growing, you might want to look here.

When Romney limited himself to a discussion of income taxes, he gave the game the away. The taxes he pays counts -- and should be reduced. The taxes the rest of pay? Not so much. The 47% include 26% who pay payroll taxes -- you know, the other big revenue stream for the government. And the remaining 21%. They're the poor, the disabled and the elderly, with some students thrown in the mix.

But they still pay taxes! The pay sales taxes, excise taxes, taxes on cell phones. Now, they may not pay much, but that's due in large part to the fact that they have don't have much money.

Undiscussed (with one notable exception) has been the role of tax expenditures. They are (more or less) the flip side of entitlements. The government can subsidize you by paying for something -- your rent, healthcare, etc. -- and that's an entitlement. But the government can also subsidize you in the form of tax breaks. Those are tax expenditures.

When Mitt Romney pays only 14% in federal income taxes because most of his income was from capital gains, he's a beneficiary -- just like someone on welfare. Except that his subsidy is a lot bigger than anything you'll ever see.

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One last point. Conservatives will argue that a lower rate for capital gains is necessary, or else people won't invest and the economy won't grow.

This is horseshit, as we showed here. The vast amount of capital gains are derived from assets purchased in the secondary market, where $0 -- not a typo -- has been invested. When you buy a stock on the open market, betting that it goes up -- that's what you're doing. You're gambling, not investing.

And we have no problem with gambling. We just want the proceeds to be taxed like everything else e.g., earned income. And fully half of these gambling proceeds go to top .1%. Again, not a typo. Not the top 1%, but the top 0.1%. 

But what about the economy? Don't lower tax rates result in more growth? Let's ask our friends at the Congressional Research Service, who just published a helpful little document called Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945.

Analysis of [the data] suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced. 

There you go. Conservatives just want a bigger slice.

Edward Conard is a Douche

The New York Times is running an article by Adam Davidson entitled The Purpose of Spectacular Wealth, According to a Spectacularly Wealthy Guy, which addresses arguments around inequality put forth by Edward Conard of Bain Capital.

Conard understands that many believe that the U.S. economy currently serves the rich at the expense of everyone else. He contends that this is largely because most Americans don’t know how the economy really works — that the superrich spend only a small portion of their wealth on personal comforts; most of their money is invested in productive businesses that make life better for everyone. “Most citizens are consumers, not investors,” he told me during one of our long, occasionally contentious conversations. “They don’t recognize the benefits to consumers that come from investment.” 

This is the usual defense of the 1 percent. Conard, however, has laid out a tightly argued case for just how much consumers actually benefit from the wealthy. 

Davidson then goes to completely avoid that tightly argued case, perhaps because it doesn't exist. Davidson does retell a story about how investment and innovation in computers has made them affordable to nearly everyone. And he even gets known pinko Dean Baker of the Center for Economic and Policy Research to acknowledge this is a true.

Baker estimates the ratio is 5 to 1, meaning that for every dollar an investor earns, the public receives the equivalent of $5 of value. 

Wow, that's pretty good!

So what's the problem? It has to do with what qualifies as an investment. Providing start-up capital to a new business, or additional capital to an already existing company, is an investment. Buying stock in the secondary market -- what most investors think of investing -- is not. It's gambling.

As we wrote here:

Unless you're involved in a public offering, all of the securities you've purchased have been in the secondary market. This means that not one dollar of the purchase price you paid went to the issuer. Instead, all of the purchase price went to someone who purchased those securities before you. You've made a bet that the security will rise in price and, if you're right, you'll win! But you won't owe taxes on gambling winnings -- which are taxed as regular income. Instead, these winnings are classified as capital gains, and taxed at a much lower rate.

Here is another example of how the tax code works to the betterment of the 1%. Capital gains (and their preferential tax treatment) are very much skewed towards the wealthy. In fact, in 2001, 2002, 2003 and 2007 (the last year for which data is available), more than 10% of all of the capital gains in the country went to just 400 tax payers.  

And those 400 returns represents those filed by the the top 0.00026%. Not the top 1%, but the top 0.026% of the top 1%. The remaining 90% of capital gains is filtered down to the 99.99974% of us.

Except that it doesn't. The top 0.1% ends up with nearly half of all capital gains, so that leaves 50% for the 99.9% of us.  

And all of that is taxed at 15%, the same tax rate which would kick in at $17,000 if you actually worked at a job. So if you made $8.50 an hour (and worked a forty hour week, fifty weeks a year), you'd be taxed at exactly the same rate which applies to the gambling winnings of the nation's wealthiest individuals.  

But it's actually worse than that, because we haven't figured in Social Security and Medicare taxes. As we noted in our discussion of Social Security,  capital gains are currently excluded from Social Security (usually 6.2%, but currently 4.2%) and Medicare (1.45%) taxation, So that's an additional 5.65%. 

This means that the lowest combined tax rate applicable to working stiffs -- 15.65% - will always be higher than the combined tax rate -- 15% -- applicable to the gambling winnings of the well-off. Always.

And it's not like Conard is an investor, at least in his professional capacity at Bain Capital. As we discussed here, private equity firms like Bain Capital are merely the leverage buy-out firms of the '80s with a makeover. Josh Kosman explained to Mike Konzal:

JK: The whole industry started in the mid-to-late 1970s. The original leveraged buyout firms saw that there were no laws against companies taking out loans to finance their own sales, like a mortgage. So when a private equity firms buys a company and puts 20 percent down, and the company puts down 80 percent, the company is responsible for repaying that. 

Now the tax angle is that the company can take the interest it pays on its loans off of taxes. That reduces the tax rate of companies after they are acquired in LBOs by about half. Banks, also realizing this tax effect, were willing to finance these deals. At the time, you could also depreciate the assets of the company you were buying — that’s not true today. 

They saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same. 

MK: So the business model is based on a capital structure and tax arbitrage? 

JK: Yes. It’s a transfer of wealth as well. It’s taking the wealth of the company and transferring it to the private equity firm, as long as it can pay down its debt.  

James Surowiecki of the New Yorker noted:

The rewards can be extraordinary: when Romney was at Bain, it supposedly earned eighty-eight per cent a year for its investors. But piles of debt also increase the risk that companies will go bust. 

And:

[B]etween 2003 and 2007 private-equity funds took more than seventy billion dollars out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.

Spectacular.

Raise Social Security Benefits

Atrios proposes it. Political Animal seconds it. And all because Joe Nocera is screwed.

My 60th birthday is less than a week and a half away, and if there is one thing I can say with certainty it’s that 60 is not the new 50. 

My body creaks and groans. My eyes aren’t what they used to be. I don’t sleep as soundly as I did just a few years ago. Lately, I’ve been seeing a lot of doctors, just to make sure everything still more or less works. 

I’ve also found myself with a sudden urge to get my house in order — just, you know, in case. Insurance, wills, that sort of thing. Sixty is when you stop pretending you’re going to live forever. You’re officially old. Or at least old-ish. 

The only thing I haven’t dealt with on my to-do checklist is retirement planning. The reason is simple: I’m not planning to retire. More accurately, I can’t retire. My 401(k) plan, which was supposed to take care of my retirement, is in tatters.

Last year, CNN reported that:

A quarter of middle-class Americans are now so pessimistic about their savings that they are planning to delay retirement until they are at least 80 years old -- two years longer than the average person is even expected to live.   

It sounds depressing, but for many it's a necessity. On average, Americans have only saved a mere 7% of the retirement nest egg they were hoping to build, according to Wells Fargo's latest retirement survey that polled 1,500 middle-class Americans.  

While respondents (whose ages ranged from 20 to 80) had median savings of only $25,000, their median retirement savings goal was $350,000. And 30% of people in their 60s -- right around the traditional retirement age of 65 -- that were surveyed had saved less than $25,000 for retirement.

But, as we discussed here,  we can "save" Social Security very easily -- mostly because it's not really in trouble. If we remove the cap on earned income subject to Social Security taxes -- currently set at $106,800 -- we would add about 0.6% worth of GDP back into Social Security. And the expected shortfall is expected to be about 0.6%. It's that easy.

But how could we raise enough money to increase Social Security benefits? We quote ourselves:

The magic words are “unearned income.” The 1% have pulled off a brilliant con over last 30 years, where they’ve been able to convince the government that unearned income – the kind that comes from capital gains, dividends and interest – should not be subject to the kind of taxation that the rest of us face. In terms of income tax, long term capital gains are taxed at 15%, far below the current maximum marginal rate of 35%. 

But it gets worse in terms of Social Security, because these things have ... never been taxed at all.  

In 2009, the IRS reported that there was nearly $7.7 trillion in income, $5.7 of which was salaries and wages. Now, just because something isn't salaries and wages does not necessarily mean it would qualify as "unearned income," but it does give us a sense of scale. If only half of it was -- $1 trillion -- then applying the 2009 employee Social Security rate of 6.2% would yield an additional $60.2 billion in revenue. 

And all of this increase would be on income -- literally -- that no one worked for.

In 2009, the average Social Security benefit was $1,153 per month (and the maximum was $2,323), and Social Security paid out a total of $686 billion in benefits. So if we were to raise Social Security benefits by 10% -- to a whopping $1268 a month (and a maximum of $2555) -- we'd need another $68.6 billion. As shown above, if we could tax half of unearned income, we'd come up with nearly 90% of that figure. We could probably make up the rest by not invading Iran.

By the way -- ever wonder how much is in the Social Security Trust Fund? It's $2.5 trillion. As the current national debt is about $15.6 trillion, that means that about 16% of our national debt is financed internally, in the form of a special series of Treasury bonds held by the Trust Fund.

How Much Did Mitt Romney Pay in Social Security and Medicare Taxes?

Update: The New York Times was able to find approximately $710,000 in earned income over the two years below. Total FICA taxes paid: about $42,000 on income of $42 million.

Nothing.

Mitt Romney offered a partial snapshot of his vast personal fortune late Monday, disclosing income of $21.7 million in 2010 and $20.9 million last year — virtually all of it profits, dividends or interest from investments. 

None came from wages, the primary source of income for most Americans. Instead, Romney and his wife, Ann, collected millions in capital gains from a profusion of investments, as well as stock dividends and interest payments.

Social Security and Medicare are financed through the FICA (Federal Insurance Contributions Act) tax, which applies only to payroll income. All other forms of income -- the capital gains, interest and dividends referenced above -- are excluded.

If all income were included, as we argued for here, Romney would have paid $3.3 million in 2010 and $2.8 million in 2011.

Full returns available here.

From Talking Points Memo

Capital Gains and Crappy Tax Policy

Recently, the Congressional Research Service published a study on changes in income distribution from 1996 to 2006, which shows, first of all, that's its good to be rich.

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

While the bottom twenty percent actually made less money in 2006 than ten years earlier, the wealthiest top 0.1% saw their pre-tax income nearly double. During that time, the average inflation-adjusted after-tax income went up 25%, but the only people who did that well were in the top 20%. The other 80% of America under-performed.


Why is that?

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

One big reason is capital gains (and dividends). The share of income derived from these sources actually went down for the bottom 80%, amounting to little more than an rounding error, while capital gains and dividends ended up contributing more than half of all income to the top 0.1%.


In fact, the "changes in capital gains and dividends was the largest contributor to the increase in the overall [measure of inequality, or] Gini coefficient."

From Wikipedia:  While developed European nations and Canada tend to have Gini indices between 0.24 and 0.36, the United States' and Mexico's Gini indices are both above 0.40, indicating that the United States (according to the US Census Bureau) and Mexico have greater inequality.

Tax policy played a roll as well. From the CRS study:

The major tax change between 1996 and 2006 was enactment of the 2001 and 2003 Bush tax cuts, which reduced taxes especially for higher-income tax filers. These tax cuts involved reduced tax rates, the introduction of the 10% tax bracket (which reduced taxes for all taxpayers), reduced the tax rates on long-term capital gains and qualified dividends, and other changes. 

In 1996, long-term capital gains were taxed at 28% (15% for lower-income taxpayers) and all dividends were taxed as ordinary income. By 2006, long-term capital gains and qualified dividends were taxed at 15% (5% for lower-income taxpayers).

So we basically cut a tax rate in half for the people who needed it the least. The bottom 80%, remember, only derived 0.7% of their income from capital gains and dividends, while the top 0.1% got a majority of their money from unearned income. 


As the CRS notes:

Tax policy changes that affect progressivity will affect after-tax income inequality. Duh.

What all this means is that the effective tax rate for the top 0.1% plummeted; they paid out nearly 33% of their income in taxes in 1996, but only 25% in 2006. This is what the Bush tax cuts did.

From Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006:  The Role of Labor Income, Capital Income, and Tax Policy by Thomas L. Hungerford

Fortunately, though, the Bush tax cuts ushered in an era of unknown economic growth.

From here.

Or not.


But the Bush tax cuts are the largest contributor to the the increase in the national deficit.

From the New York Times.

So, in summary, if you want to reduce the deficit, improve income equality and maybe remove the jackboot of capitalism from the trachea of the bottom 20% of Americans, all without affecting the economic performance of the country, start taxing capital gains as ordinary income now.


Bonus: Taxing capital gains also fixes Social Security!

Taxes -- The Semi-Concise Summary

So ... how to fix America's personal income tax problems?

1. Expand the number of brackets to what they were during the early Reagan years, and bring the top marginal rate back to the 50% it was back then. It was good enough for St. Ronnie; it's good enough for today. 
2. Get rid of the capital gains tax. Treat all income as ordinary income. 
3. Junk the mortgage interest deduction. OK, just phase it out then.
4. Set the trigger for the alternative minimum tax at $250,000 (for a household) and adjust it automatically for inflation.

The result will be a much simpler tax code that raises considerably more money, with nearly all of that additional revenue coming from the top 1% or so. And, with a little luck, we should be able to offer some mild tax relief for the poor and middle class. 

One last thing. One of the more pernicious lies bandied about this past year was that 47% of American didn't pay federal taxes. In fact, everyone who gets paid to work paid federal taxes in the form of FICA -- Social Security and Medicaid taxes. But because these taxes are tallied separately from income taxes, they get forgotten. 

And this really doesn't make sense, because Social Security and Medicaid is what a lot of what the federal government does.

2010 Federal Budget -- Outlay by Category

In 2010, Social Security and Medicaid accounted for about 28% of the federal budget -- and everyone helped pay for it. 

(If you add in Medicare and defense spending, you end up accounting for about two-thirds of the budget -- which is why government is sometimes called "an insurance company with an army.")

It's time for the lie to die. So from now on, FICA taxes are rolled into general personal income taxes. Nothing under the hood will change -- FICA taxes will still be deducted from paychecks as they have been. Technically, your marginal rates will go up, but the FICA taxes you already paid will offset them entirely. You'll net out, but it will be now be clear how much you're actually paying to keep the government going.

T's for Taxes; T's for Tennessee -- Part III (Carried Interest)

We’ve tackled some pretty big tax reform ideas lately – we pined for the higher marginal tax rates and greater number of brackets under Reagan here, and talked about the tax break for the well-off known as capital gains here. So let’s address a smaller, less controversial idea today. 


In fact, today’s problem is so small … we’ve already solved it through our reforms on capital gains. But it will serve as a good lesson on how the privileged tax position of capital gains is exploited by the most well-off.

This loophole is known as carried interest, which is the

right to receive a specified share (often 20 percent) of the profits ultimately earned by an investment fund without contributing a corresponding share of the fund’s financial capital.  It is part of the standard compensation package for managers of private equity funds [and hedge funds, and a bunch of commercial real estate concerns as well]. 

Current law allows these managers to pay tax on all or most of their carried interest income at the 15 percent capital gains rate, instead of at the individual income tax rate that would otherwise apply, typically 35 percent for these high-income individuals. Rather than being taxed as managers receiving compensation for services rendered, recipients of a carried interest are taxed as though they were investors who had supplied 20 percent of the financial capital of the fund. 

If you’re a hedge fund manager, a typical compensation package might be a two-and-twenty – meaning that you would receive an amount equal to 2% of all the assets under management, as well as a 20% share of any profits – a performance fee. (Other factors – things like high water marks and expenses– will affect compensation, so this is a simplified version).

So let’s say you’re managing a small hedge fund with $100 million in assets. Because you are a very good manager, the fund makes $10 million this year. You will receive $2 million as your compensation, which will be taxed as ordinary income. But you will also receive 20% of $10 million, or another $2 million, as carried interest/performance fee. And this is the part which gets taxed as capital gains.

Why does this get taxed as capital gains? There's really no good reason. Proponents will argue that the 20% represents the gains that the manager would have received had he invested 20% of the capital of the fund. True ... but that's not what he did. The manager contributed ... nothing. Literally. 

The manager has provided a service, and he should be compensated (and taxed) for that. But in terms of capital ... the manager didn't add a single penny.

So how does this play out? Referring to our marginal tax rates chart:

2011 Taxes on $2,000,000
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$17,000	$17,000	$1,700.0
15.0%	$17,000	$50,000	$33,000	$4,950.0
25.0%	$69,000	$139,350	$70,350	$17,587.5
28.0%	$139,350	$212,300	$72,950	$20,426.0
33.0%	$212,300	$379,150	$166,850	$55,060.5
35.0%	$379,150	$2,000,000	$1,620,850	$567,297.5
				$667,021.5

2011 Capital Gains Taxes on $212,300
Tax Rate	Over	But Not Over
15.0%	$17,000	$2,000,000	$2,000,000	$300,000
		-
				$300,000

So the manager would have a total tax liability of $967,000. But if we recognized all of the $4 million as ordinary income, then his tax bill would be much higher.

2011 Taxes on $4,000,000
Marginal	Tax Brackets
Tax Rate	Over	But Not Over
10.0%	$0	$17,000	$17,000	$1,700.0
15.0%	$17,000	$50,000	$33,000	$4,950.0
25.0%	$69,000	$139,350	$70,350	$17,587.5
28.0%	$139,350	$212,300	$72,950	$20,426.0
33.0%	$212,300	$379,150	$166,850	$55,060.5
35.0%	$379,150	$4,000,000	$3,620,850	$1,267,297.5
				$1,367,021.5

Yes, we're currently giving tax breaks to hedge fund managers. We're that screwed up.

(For the sake of comparison, Topeka is now so broke that they're simply not prosecuting misdemeanors any more (including those for domestic violence).)

But as we noted earlier, this problem has already been solved. By taxing capital gains as ordinary income, this tax break simply disappears. It won't matter what the manager's compensation is called, or whether he made a capital contribution, because it will all be taxed the same.

Because income ... is income ... is income ... is income.

Disclaimer: The brackets above cannot be used to calculate actual tax liabilities without including other factors, most notably -- deductions. But they are indicative of tax liabilities over time, and between the well-off and the just-getting-by.