Maximum Real Wage

by Scott

I’ve been throwing around ideas with DA about the debate surrounding the “carried interest loophole” whereby the income from the activity of private equity/VC management is structured in such a way to get capital gains treatment in the tax code.

This topic is of great interest to DA as he is seeing, potentially, the door close on this treatment right in front of him before he can “get his” with his newly launched inaugural fund.

Our conversations generally fluctuated around: “PE guys (and their lawyers) can structure around anything” to me bemoaning the state of complexity in the society when the government can’t even change taxation on an established industry without it devolving into a hundred shell companies, and atomizing into lawyerly language parsing and debates on “it depending on what the definition of ‘is’ is”

Today I came across a video from the Private Equity Growth Capital Council  that has their pitch on why Carried Interest should be treated as Capital Gains.

What is Carried Interest? Whiteboard Video

I knew the video would be good for at least a few laughs and I was not disappointed.[11.Apparently, Henry Kravis is providing “sweat equity” in this whole equation.] But overall, I found the video fairly convincing, but more interestingly, at least to me, is it prompted in me a possible new direction on this debate:

What is the theoretical maximum real wage that a person can earn?

Us human beings are on the earth 8,760 hours per year. Leonard Bosack, co-founder of Cisco, said that commitment starts at working 100 hours a week. So humans probably have a maximal capacity to “work” 5,200 hours per year. What’s the most a productive a person can be on an hourly basis? Really? $500 per hour? $1,000 per hour? $2.6 million – $5.2 million a year?

Perhaps we can remold our tax code around the idea of a “Maximum Real Wage.” Anything under the “Maximum Real Wage” is earned income, anything over is “Return on Risk.”

Let’s say Tom Cruise’s quote for a movie is $25 million in 1099 income and we have eight weeks of principal photography. How much value does his labor provide for those eight weeks? Sure, he’s got to be on location, and he’s got to wake up at odd times and he’s got to stand on mark and deliver the lines… but how much of that value is related to his “brand” and lifetime of work honing his trade and all those little things he did over the years to cultivate the right public image and keep things under control so he does not come off like a manic?

It seems to me a lot of that $25 million is related to what corporate accounting would call returns on “intangible assets.”

Next year Cruise could suffer a debilitating public relations scandal and his ability to earn would be impaired forever.

But going back to the beginning of this scenario: what if Cruise structured most of his compensation as “back end participation”? Do we now change how it’s taxed?

I wonder if the long elusive simplification of the tax code could be based on a new economic reality, Maximum Real Wage, rather than whatever tortured legal structure that the individuals being taxed come up with.

Which brings me back to Private Equity: OK, some of this income is attributable to “earned wages” but can a person really earn $100′s of millions in wages?