Those who can often be found at the very top of the earnings scale – people who manage private investment funds such as hedge funds or private equity and venture funds – enjoy a tax loophole that allows the money they make by investing money for others (their “carried interest”) to be taxed as capital gains rather than earned income, even though they earn the money from work, not as a return on investing their own money.
In plain terms, they reap a benefit even though they don’t put their own capital at risk. It’s a loophole that allows the rich to get richer, and its demise is long overdue. That is why some of the wealthiest Americans pay lower tax rates than their secretaries. Proponents argue that taxing those who run these funds at the same rate that everyone else pays on their earned income would drive away trillions of investment dollars.
These are the same folks, the 1-percenters, who can enjoy indulging in any of the 40 items on the Forbes cost of living extremely well index (CLEWI). The list, which should not be shared with progressive friends, includes such items as a Learjet, 45 minutes with a shrink on the Upper East Side of Manhattan, Russian sable fur coats, a Har-Tru crushed stone tennis court and more. Forbes says, the CLEWI is to the very rich what the CPI is to “ordinary people.”
The term carried interest goes back to medieval merchants in Genoa, Pisa, Florence, and Venice. These traders carried cargo on their ships belonging to other people and earned 20 percent of the ultimate profits on the “carried product.”
Today, those who manage investments in private equity funds are typically compensated in two ways: with a 2 percent fee on funds under management and a 20 percent cut of the gains they produce for investors. The 20 percent in profits these managers pocket, known as carried interest, is currently treated as a long-term capital gain and taxed at 23.8 percent: the capital gains rate of 20 percent plus the Obamacare surcharge of 3.8 percent on their income. The 2 percent management fee is taxed at the higher ordinary income tax rate.
While these sweeping tax proposals do not specifically address carried interest, it might be reasonably inferred that carried interest would be taxed as ordinary income rates. In the past, Biden has said he’d like to eliminate the carried interest giveaway. Both Presidents Obama and Trump campaigned on closing the carried interest dodge, yet it’s still there. Their proposals to abolish the carried interest preference were met with pregnant and deadening silence in Congress.
Eliminating the carried interest provision that allows fund managers to get away with bargain basement tax rates should be low-hanging fruit given the inequality of wealth and income in the United States. Yet despite its unpopularity this is the tax break that just won’t die. Well-connected lobbyists and trade groups for private equity, hedge funds, and others have mobilized their resources and fought successfully to keep carried interest as is. The nine lives of carried interest are more evidence, if any more evidence is needed, that big money gets its way in Congress. Here’s hoping that the conceit of closing the carried interest loophole will gain traction but for sure it’s a long shot.
