When It Comes to Tax Loopholes, Don't Hate the Player, Hate the Game

President Obama’s recent comments during a CBS news interview about closing tax loopholes have been getting a lot of attention lately, while his acknowledgement that spending cuts are also a must has been largely ignored. This fits nicely into the simplistic media narrative of Democrats as socialist Robin Hood figures and Republicans as Robber Barons. Either you’re on the side of the rich or the poor. Either you want to raise taxes or cut spending.

For all his talk of bipartisanship, Obama often doesn’t help the situation (his reference to “Cayman Island” accounts later in the interview was no doubt a shot at Romney). However, what both parties really want is to lower the deficit, and to do so we’ll have to rethink both revenues and expenses in less simplistic terms. Tax loopholes encompass an incredibly wide array laws, therefore they need to be discussed on a case-by-case basis.

Are there circumstances where it makes sense for certain individuals to pay less than their normal tax bracket requires? People would be less likely to contribute significant percentages of their income to charitable organizations if the tax break for donations were taken away. However, according to the New York Times, “Budget experts say that to raise substantial revenue through loopholes and deductions, lawmakers would have to focus on deductions on mortgage interest payments and charitable donations.”

Tax “loopholes” and subsidies have also been instrumental in the expansion of fledgling industries, such as our renewable energy sector — job creation, clean air initiatives, and hope for the future. New technologies often need tax breaks in the beginning so that more funds can be put toward the research and development of more cost effective methods of production.

However, sometimes tax loopholes can be utilized in a way not originally intended. Their abuse provides society with little to no benefit to compensate for the lost revenue. One of the Obama administration’s loophole provisions that has received almost no media coverage involves preventing companies that create certain paper byproducts from utilizing the cellulosic biofuels producer credit.

In the CBS interview, Obama also stated that he wanted to close the “carried interest income” loophole. Carried interest is a percentage (usually 20-25%) of profits that a private equity or hedge fund gives to its management. This income is taxed at the capital gains level, which is 20% for earners in the 39.6% tax bracket (the 39.6% bracket includes single filers earning above $400,000; married filers earning over $450,000; or married couples filing above $225,000 separately).

Some view the possible closure of this loophole as a punishment for success, however I feel that the fair tax rate for varying income levels is for another discussion. This is a question of whether earning carried interest income should entitle a person to pay less taxes than if the same amount of money was earned another way. Does giving these managers lower tax rates provide any benefit for society?

While the additional income could motivate managers to be more productive, thus improving their own finances in addition to the stockholders' and the economy as a whole, managers would have plenty of motivation either way. They’d still be getting a percentage of profits and pressure from shareholders.

Too often, when people disagree with a particular loophole, their argument consists of calling people who’ve taken advantage of these opportunities expletives and “thieves.” I’ll be the first to admit that I would utilize any legal tax loophole available to me. I don’t know anyone who wouldn’t. The question is, which tax loopholes should exist?