Romney Loophole

Democrats can still close the Romney Loophole

January 2, 2013: 2:49 PM ET

taxesDemocrats still have some revenue-raising options after their fiscal cliff win.

FORTUNE -- Democrats apparently are worried that they won't have any leverage in upcoming debt ceiling and sequestration debates, after succeeding last night in raising taxes on America's top earners. It's a bit like a Super Bowl-winning team fretting over its free agents before even having the parade. So here's a bright spot for those on the left who refuse to savor the sweet taste of victory: You've still got the Romney Loophole.

Yesterday's fiscal cliff agreement was chock full of tax rate extensions, but did virtually nothing in terms of closing tax loopholes. This includes carried interest, which continues to be treated like a capital gain rather than as ordinary income. Democrats still can, and should, go after this in the next round of talks. And explicitly tie it to Romney, since very few Americans are passionate over capital markets jargon like "carried interest."

(Note to the literal-minded: Of course it's not really about Romney, but the JOBS Act wasn't really about jobs. Names matter when it comes to getting legislation passed.).

For the uninitiated, the Romney Loophole allows investment managers like private equity execs and venture capitalists to pay an artificially-low tax rate on profits earned by investments made with other people's money. They do this by pooling third-party investments into limited partnerships, and then pretending like their cut -- generally between 20% and 30% -- is somehow a reward for their own risk-taking. Some private equity execs even exploit this loophole to greater effect by "waiving" their management fees -- monies typically taxed at ordinary income rates -- so that almost all of their potential income can be treated as capital gains.

Yes, the fiscal cliff deal increases capital gains rates for relevant income over $400,000 (or over $450,000 for joint filers), but that's a far cry from the 35% rate at which carried interest would be taxed as ordinary income.

MORE: The case for raising taxes on private equity

Democrats like President Obama and Harry Reid have talked for years about closing the Romney Loophole since 2007, but have followed-up with a combination of ambivalence and incompetence. Almost as if they'd prefer to keep the unfair preference alive as grist for future campaign ads.

If that continues to be the case going forward, then there isn't much that rational adults can do about it. If, however, Democrats are serious about seeking reasonable revenue measures to use in negotiations with Republicans over the next few months, they've got one.

Moreover, it should be an easy win. Mitt Romney himself wouldn't even take a position on carried interest taxation during the last election, and Grover Norquist has signaled that closing certain loopholes is not a violation of his lead-plated pledge. Even a number of high-profile private equity execs and venture capitalists (read: campaign donors) have acknowledged that the current tax rules are illogical, while almost all believe that they will be changed at some point.

The political stars are perfectly aligned for a tax change that makes perfect nonpartisan sense. Shouldn't that be enough to finally get it done?

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