When U.S. House Ways and Means Committee Chairman Richard Neal on Monday proposed a major set of tax hikes to fund Democratic President Joe Biden’s social spending plans, one tax break popular among major Democratic Party donors was left in place—the taxation of carried interest income at the lower capital gains rate.
President Joe Biden’s American Families Plan originally included an end to what critics describe as the carried interest “loophole,” a wrinkle in the tax code that allows managers of hedge funds and private equity funds to treat some income generated from their investment activity as capital gains, which are taxed at a much lower rate than ordinary income. Biden’s proposal would have treated such gains as ordinary income—raising the rate from 20 percent today to 39.6 percent—for any taxpayer earning $1 million or more.
But following months of ferocious lobbying by the private equity industry, the tax break has survived. The Democrat proposal now merely lengthens the amount of time an investment must be held to qualify for capital gains treatment from three to five years, a change that people familiar with the matter was actually crafted by lobbyists for private equity.
The current form of the carried interest tax break is much more beneficial to private equity funds than traditional hedge funds because hedge funds rarely hold assets long enough to qualify for capital gains treatment. Private equity funds frequently do.
Cynics have long charged the Democrats with raging against carried interest only in hopes of exciting populist resentment to win elections and to attract donations from fund managers eager to water down any reforms. The disappearance of significant changes to carried interest taxation from the latest proposal supports those charges.
“Yet when Democrats have power, they never seem to kill the provision. And, lo, the draft Ways and Means bill merely extends the holding period to five years from three. Faced with offending some of their wealthiest financiers, the Democrats are blinking,” the Wall Street Journal editorial page said on Tuesday.
Clifford Asness, who founded the asset management firm AQR Capital Management, mocked Alexandria Ocasio-Cortez’s “tax the rich” dress in light of the omission of carried interest from the Democrat tax hikes.
Hedge funds and private equity funds are typically organized as partnerships, with the managers of the funds entitled to receive part of the profits if the investments perform well enough. The manager’s share of the profits is known as “carried interest.” Under current law, the share of profits that goes to the outside investors and the managers get the same treatment, meaning they can qualify for the lower capital gains rate.
Over the summer, the National Association of Investment Companies, a private equity trade group, sent a letter to Rep. Richard Neal (D-MA) arguing that private equity funds “fuel” pension funds for city, state and, federal workers, as well as support endowments and foundations, according to Bloomberg News. Another private equity lobbying group, the American Investment Council, has targeted 25 Members of Congress with a campaign that characterized raising taxes on carried interest as discouraging private equity investments in their states and districts, Bloomberg reported. Among those targeted have been Senators Kyrsten Sinema and Mark Kelly, both Arizona Democrats, as well as Senator Corey Booker (D-NJ) and Mark Warner (D-VA).
Private equity linked donors overwhelmingly favored Biden over Donald Trump in the 2020 election, just as they favored Hillary Clinton in 2016.