The Carried Interest Tax: A Rebuttal

Fred Wilson recently added to the debate over taxing carried interest as ordinary income instead of capital gains (Click here for a primer, or click here to learn about possible new tax breaks for Angels). The core argument is that if invested capital in startups were to be taxed as ordinary income it would result in significant tax savings for the investors – maybe a good thing.

Wilson’s entry has a few good points, especially his statement ’we need a tax code that creates some incentives to take risk or wealthy people will be less inclined to do so.’Â�

However two of the arguments demand deeper examination. First, I think there is a big point Fred misses when he states ’Entrepreneurs and investors who risk their capital in an attempt to create new businesses that employ people, make our lives better, our businesses more efficient, etc should be rewarded for doing so’ ’ My question is who does ’our lives’ refer to? Because really aren’t ’our lives,’ actually the lives of the privileged?

Think about it; who actually invests in venture funds or private equity? Who are the people starting the companies VC’s invest in? As MBA’s we all learn the first thing a good VC or Angel does is to look at the management team, aka, ’pedigree.’ Harvard, Wharton, friends, family money, etc’ Also, who are the people these startups are hiring? Is it the underprivileged blue collar workers, or is it the guys with computer science degrees and MBAs living in the Valley?

The other point I take issue with is the notion that an Angel should be taxed in the same manner as a Venture Fund. I see a big difference between someone willing to take on personal exposure (put their own assets at risk) versus a fund who simply can close shop, at worst loosing their reputation and a URL’ if that.

So, how would I change the system? Well, I would suggest that for venture funds to be taxed in the same manner as Angels, funds should need to devote a percentage of investments to either their immediate local economy, or to an organization more along the lines of microfinance, a la Kiva. Kiva or Grameen are the types of business that really make the greatest impact and truly improve lives. For example, does the social network Eons really need $22 Million to launch essentially the same business that could be launched via open source for under $50k? I could also see a difference in taxation policy for investments on behalf of non-profits or school endowments.
I completely agree that encouraging the wealthy to stimulate the economy through investment is the right move; I simply suggest we take a hard look at who is truly benefiting and put in the proper checks and balances.


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