Incredible unfairness in the US tax code – IRC: Confusing capital gains with income edition

Unfairness to the general public:

There are those who believe that Mitt Romney has a number of “carried interests’ and takes advantage of the unfairness because:

Unfair to U.S. citizens abroad:

On the other hand, if  you are a poor U.S. citizen abroad you will be destroyed by the unfairness of your non-U.S. mutual fund being subject to the PFIC provisions because:

I guess the U.S. tax code is simply unfair!

But, why is it unfair? What is going on here? In March of 2012, Fareed Zakaria, did an interesting analysis on CNN called:

America needs a two page tax code. I highly recommend it.

Mr. Zakaria notes that:

We’re going to hear a lot of polarized rhetoric over the next few months. The Republicans and Democrats will seem to disagree about everything. But there is one huge and important area where there is a possibility – a possibility – of bipartisan action and that’s tax reform.

Most Americans – Republicans and Democrats – dislike the tax code. They’re right to do so. America has what is arguably the world’s most complex tax code. The federal code plus IRS rulings is now 70,000 pages long. The code itself is 16,000 pages. The statist French, for example, have a tax code of only 1,909 pages – only 12% as long as ours. And then there are countries like Russia, the Czech Republic, Estonia that have innovated and moved to a flat tax, with considerable success.

You have to understand, complexity equals corruption.

When John McCain was still a raging reformer, he used to point out that the tax code was the foundation for the corruption of American politics. Special interests pay politicians vast amounts of cash for their campaigns and in return they get favorable exemptions, credits or loopholes in the tax code.

In other countries this sort of bribery takes place underneath bridges and with cash in brown envelopes. In America it is institutionalized and legal but it is the same thing: Cash to politicians in return for favorable treatment from the government.

The U.S. tax system is not simply corrupt, it is corrupt in a deceptive manner that has degraded the entire system of American government. Congress is able to funnel vast sums of money in perpetuity to its favored funders through the tax code without anyone realizing it.

The examples given in this post are examples of extreme unfairness. How an it be that an “carried interest”, taxed as a capital gain? How an it be that investing in a Franklin Templeton mutual fund in Canada is taxed in such a punative way when to invest in the same fund in the U.S is not?

It is obvious that the difference in tax treatment is unrelated to the differences in the substance in the investment. The treatment is clearly the result of other considerations.

I suspect that the perverse tax treatement – the “PFICization” of foreign mutual funds is the result of lobbying from the U.S. mutual fund industry (and to apply this to U.S. citizens living outside the U.S. is absurd). What about the “carried interest” issue? Could lobbying be a factor here?

In the mean time, I highly recommend Fareed  Zakaria’s commentary on the U.S. tax code.

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