Mitt Romney is about to release a couple of years of tax returns. The numbers are sure to be enormous. Except for one: his marginal tax rate, an outrageous 15%, or thereabouts. James Surowiecki has a terrific column in the New Yorker that explains why the taxes Romney paid have always been low. It’s all about the so-called “carried interest” loophole, which enables private equity-mongers to have their salaries taxed at the capital gains rate of 15%, rather than as earned income. Surowiecki also explains some of the scams private equity firms–not necessarily Bain Capital–have used to milk ever-greater profits from the firms they buy. Most of these scams involve taking out ever-greater loans. And that is one of the three basic problems with private equity as a capitalist tool–it replaces equity with debt. (It is hilariously ironic that Mitt Romney goes around ranting about the national debt, having made his fortune via the creative use of hyper-borrowing.)
There are two other problems with private equity that Surowiecki doesn’t mention. Historically, firms like Bain have jacked up executive compensation, as a reward to CEOs who can find ways to cut costs and make their operations more efficient. The second problem is linked to the first: in order to reap those benefits, for themselves and the private equity firms’ investors, corporate executives have become obsessed with short-term profits rather than long-term growth.
Romney tries to portray those who question the private equity model as anti-free enterprise, which is nonsense. And most liberals–and now populist conservatives–who attack the model concentrate on the job losses, which is also somewhat off the mark. The real question is this: Does private equity capitalism help or hurt the economy in the long term? Should the rules governing it be reformed? I agree with Surowiecki: the “carried interest” loophole needs to be eliminated. And there should be a limit on the amount of interest payments these firms can deduct from their income. We’ve spent the past 30 years spending hundreds of billions rewarding non-productive investment. It’s time to eliminate this distortion of the free-market system by leveling the playing field.