DealBook: An Addition to the List of Tax Loopholes

Pablo Martinez Monsivais/Associated PressPresident Obama at his news briefing on Monday on the nation’s deficit. Mr. Obama has called for ending a variety of tax loopholes.

As the White House and Congress wrangle over raising the debt ceiling and reducing the federal deficit, tax loopholes would seem to be an easy target for compromise.

President Obama has talked about eliminating breaks for partners at hedge funds and private equity firms — along with corporate jet owners, oil companies and others taking advantage of quirks in the tax codes.

Here’s another little-known group of tax code beneficiaries that he might want to add to the list: day traders and speculators who buy and sell futures contracts.

For years, futures contracts, which are essentially bets on the price of commodities, stock indexes and the like, have received a more favorable tax treatment than stocks. A trader who buys and sells an oil contract in less than a year — even in a matter of minutes — pays no more than a 23 percent tax on the profits.

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Compare that with the bill for flipping shares of Google, General Electric or even a diversified mutual fund in the same time period. Those short-term investment gains are treated like ordinary income, meaning the rate can run as high as 35 percent.

“There are so many ways to attack the logic of it,” Warren E. Buffett, the chairman of Berkshire Hathaway, said in an interview on Monday about of the futures tax break. “It doesn’t make sense.”

What does the tax loophole cost the federal government? Each year, the United States gives up roughly $2 billion in lost revenue, according to the Congressional Research Service, a federal agency.

While that number may seem insignificant against the backdrop of the country’s $55 trillion debt load, tax inequities like this start to add up when considered collectively. Based on data from the Office of Management and Budget, the United States could put another $20 billion in its coffers over 10 years if it taxed the investment gains of hedge funds and private equity executives as ordinary income. The so-called carried interest is treated like capital gains, which is taxed at a much lower rate. The corporate jet break amounts to about $2 billion to $3 billion in a decade.

Perhaps the tax break on futures contracts wouldn’t be so irksome if it simply helped farmers protecting the value of their corn crops, airlines dealing with the rising cost of oil or even individuals hedging the risks in their portfolio.

But the biggest beneficiaries seem to be day traders and speculators. Long-term investors account for only 20 percent of the activity in the commodities future market, according to a report published last week by the Commodity Futures Trading Commission, the industry regulator.

When I called Robert Green, a tax specialist whose clients include traders on the Chicago Mercantile Exchange, the hub of commodities futures contracts, he seemed genuinely taken aback.

“I’ve been dreading getting a call like this,” he said, apparently worried that any publicity of the tax break could put pressure on lawmakers to revisit the rule. “No one has shot something across the bow.”

Still, he acknowledged that it would be hard for President Obama to justify lower tax rates “to benefit futures traders and commodities exchanges in his home state, while pushing hard to raise taxes on securities hedge fund managers — often in Connecticut and New York City.”

The genesis of the tax break on futures goes back to 1981, when the government tried to close another tax loophole. At the time, some big investors were using the contracts to skirt taxes by creating what was called a straddle transaction, which allowed investors to roll over their profits into the next year. So a rule was written that forced traders to mark their positions to market and pay taxes on unrealized gains.

In an effort to appease the investment community, a break was offered by Dan Rostenkowski, a Democrat from Chicago who was then the chairman of the House Ways and Means Committee and later went to prison for corruption. In part, the break was meant to offset the risks associated with paying taxes on paper profits. He persuaded Congress that traders should pay a blended rate, paying 60 percent of the long-term capital gains rate and 40 percent of the ordinary income rate. Today, the combination amounts to about 23 percent, assuming the top tax bracket for ordinary income is 35 percent and the long-term capital gains rate is 15 percent.

The break has been on the chopping block in recent years. In his budget proposals for 2010 and 2011, President Obama recommended ending the special tax treatment for dealers of futures contracts, although not for all investors. But the plans lost momentum and neither was incorporated into the final budgets.

Eric J. Toder, an economist at the Tax Policy Center, a research organization, said that the tax break might have made sense a generation ago when the market was mainly investors protecting their long-term profits. But with speculators betting on short-term price movements, the loophole is just that — a loophole.

“It seemed like a reasonable compromise at the time to stop the straddle transactions,” Mr. Toder said. “In retrospect, if the trading is so short term, it seems a little silly to give them preferential treatment.”

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