Congress Must Exercise Caution on Tax Changes

Posted September 24, 2007 at 11:20am

First, do no harm.

That should be Congress’ catchphrase. The mounting challenges threatening America’s supremacy as an economy and magnet for capital investment should require Congress to exercise extreme caution in contemplating tax increases. Yet despite the skittishness of our capital markets and the slashing of tax rates on investment around the world, a desire to find offsets for increased spending has instead fueled a drive for antigrowth tax hikes. Now it’s time for us to take a sober look at the harm tax increases would cause to the economy, job creation and the savings of ordinary Americans.

Consider legislation proposed by Reps. Sander Levin (D-Mich.) and Charlie Rangel (D-N.Y.). The Levin-Rangel bill would slap investment partnerships with a whopping 133 percent tax increase on carried interest, the profits that business partnerships earn for generating wealth. It would raise taxes on the people who put in the hard work and sweat equity to build businesses.

The unintended consequences of this investment disincentive would be far-reaching. Among the primary casualties would be millions of blue-jeans-wearing Americans whose pensions and jobs increasingly rely on the fruitful returns they reap from both large and small investment partnerships. Washington’s state employee pension fund, for example, has earned $9.71 billion, or approximately $26,000 per worker, in its 25 years of investing in partnerships. Levin-Rangel is a clear attack on the pensions of every teacher, firefighter, police officer and civil servant whose pension is tied to these funds.

The measure also would hammer small and mid-level investment funds run by minorities and women; millions of Americans in low-income and other typically neglected communities into which partnership investment has breathed new life; and hundreds of struggling companies that rely on partnerships as a crucial source of capital to rejuvenate their enterprises (private equity investment alone created about 600,000 jobs from 2000 to 2003, according to A.T. Kearney Inc.).

So much for fairness, the word many of the bill’s supporters employ to inoculate their plan against scrutiny and attack.

And then there’s the damage to the financial markets. As a painful credit crunch continues to roil the markets, we must recognize that now is not the time for crippling tax increases that promise to further drain liquidity and capital formation in this country. Why would we throw up barriers to investment when we so badly need incentives?

Partnerships, especially private equity funds, already have seen their ability to earn attractive returns on equity that has been diminished by drying credit markets. Levin-Rangel, coming at such a critical juncture for capital markets, will only further deplete one of the most vital pools of capital. The stiffening of taxes on partnership-asset returns risks steering untold billions away from our capital markets and to places overseas. Such a flight of capital will depress asset prices and send even more shockwaves through the stock market.

As the markets try to recover from a state of financial panic, the Federal Reserve already is carrying out its duty to provide the underlying basis for future economic health. Chairman Ben Bernanke already cut the discount rate — at which banks can borrow money from the Federal Reserve — and on Tuesday reduced the federal funds rate. But Bernanke’s efforts may prove futile if Congress shows an inclination for antigrowth tax policy.

According to Jack Levin, an expert and author of several treatises on venture capital and entrepreneurship who recently testified before the Ways and Means Committee: “It is the antithesis of the free market when Congress enacts tax laws targeting specific activities and designating winners and losers, for example, taxing carried interest in venture capital, private equity, real estate, and hedge funds more harshly than other types of carried interest and more harshly than other investment gains. When Congress enacts laws picking winners and losers, with the tax rates and rules differing by industry, the free market is inevitably distorted, with great risk of dire long-term consequences for American economic growth.”

A recent Ways and Means hearing featured a litany of “creative” ideas to pile a heftier tax burden onto the backs of American families. Congress’ newly implemented pay-as-you-go rules require every dollar of additional spending to be offset. That bodes ill considering the blithe disregard for fiscal responsibility among far too many in this town. Congress already has increased spending by 10 percent over last year’s levels, and with the ’08 elections looming, more is guaranteed to come.

The tax hike on carried interest is just the tip of the iceberg — the opening salvo of a larger attempt to restructure the tax system. Some of the same politicians who support Levin-Rangel also would eliminate capital gains treatment entirely.

Every day in America, businesses begin with ordinary people with an idea. That idea, when combined with investors, hard work and expertise, results in successful businesses and more jobs. Levin-Rangel, however, suppresses the most innovative and energetic part of our economy. In an increasingly challenging global community, America must stay competitive.

Rangel recently told the Ways and Means Committee that “one of the fundamental duties of the Committee on Ways and Means is to conduct oversight of the tax code and ensure that our tax laws promote fairness and equity for America’s working families.” It’s difficult to believe that the committee would be fulfilling its duty by imposing a tax that affects millions of investors and retirees and would be so disadvantageous to the U.S. economy.

Rep. Eric Cantor (R-Va.) is the House Chief Deputy Minority Whip and a member of the Ways and Means Committee.