President Obama today stressed in his speech that when it comes to spending, it is important to comb the budget with a “scalpel but not a machete.” But when it comes to tax hikes — or as the president calls it, reducing “tax expenditures” — the Obama administration is charging at small businesses and venture capital with a Texas-size chainsaw.
In his speech, the president was short on specifics, but referenced his 2012 budget for proposals to remove “tax expenditures.” But in addition to raising tax rates, the budget contains direct attacks on the structure of partnerships that are used by innovative businesses — from small firms to venture capital and private equity groups — that make an outsized contribution to economic growth and job creation.
And recent testimony by Treasury Secretary Tim Geithner hints at take hikes that would also eviscerate subchapter S corporations (S-corps) relied on by small business entrepreneurs. If the tax hikes on S-corps are similar to the ones proposed last year by the then-Democratic controlled House Ways and Means Committee, they would hit small businesses engaged in such services such as “management, health, law … engineering, architecture, accounting, actuarial science, and consulting,” according to an analysis from the global law firm Ropes & Gray.
In unveiling his deficit reduction plan, Obama stated that his spending cuts “will not sacrifice the core investments we need to grow and create jobs” Yet his tax hikes on entrepreneurs and innovators would do just that and put in jeopardy America’s chance to, in the president’s famous phrase, “win the future.”
Take the president’s proposal in his 2012 budget to tax “carried interest.” Proponents of this tax want you to believe that this will only hit hedge funds. Not that there is anything wrong with hedge funds — as I have written, they are one of the best forces to hold CEOs accountable to all shareholders — but the tax would actually have a much broader reach.
In a partnership — hedge fund, venture capital, private equity or any kind — the partners are taxed on a business’ earnings at individual tax rates instead of the business itself being taxed at corporate rates. In a limited partnership, the general partner gets an ownership stake in exchange for managing the firm and assuming all the legal liabilities for the other partners. He or she will be taxed at the rates of ordinary income for management fees, and for much of the business’ activities. But the general partner will pay the individual capital gains rate when the other partners receive capital gains for sales of such assets as stock and real estate. This is called the “carried interest.”
What the president’s proposal would do is tax the general partner’s carried interest as ordinary income, more than doubling the rate in some cases from the current top capital gains rate of 15 percent to the top personal income tax rate of 35 percent. In addition, it would subject some of these earnings to Social Security and Medicare payroll taxes. This could more than triple the rate of taxation for small businesses as well as venture capital and angel investing firms, including those that provide seed capital to the president’s priorities of medical research and alternative energy.
In short, the president’s tax hikes on innovation and entrepreneurship are a recipe for losing the future.