The Carried Interest Loophole Survives Another Political Battle

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WASHINGTON – Once again, interest bore the day.

The Senate Democrats’ last-minute removal of a provision in the climate and tax law that would narrow the so-called “carried interest loophole” represents the latest victory for the private equity and hedge fund sectors. For years, those companies have successfully lobbied to destroy bills aimed at ending or limiting a quirk in the tax code that could allow wealthy executives to pay lower tax rates than many of their salaried employees.

In recent weeks, it looked like the benefit could be scaled back, but a last-minute intervention by Arizona Democrat Senator Kyrsten Sinema put an end to what would have been a $14 billion tax hike targeting private equity. .

The failure of lawmakers to address a tax break that Democrats and some Republicans believe is unfair underscores the political power of financial industry lobbyists and how difficult it can be to change a tax code that would affect members of both parties. call it unfair.

The deal that Democratic leaders made with Ms. Sinema not only abolished the carry-interest provision, but also included a 1 percent excise tax on share buybacks and changes to a minimum 15 percent corporate tax that favored manufacturers.

On Friday, the private equity and hedge fund sectors applauded the development, describing it as a win for small businesses.

“The private equity sector directly employs more than 11 million Americans, fuels thousands of small businesses, and provides the highest return on pensions,” said Drew Maloney, chief executive of the American Investment Council, a lobbying group. “We encourage Congress to continue to support private capital investment in every state in our country.”

Bryan Corbett, the chief executive of the Managed Funds Association, said: “We are pleased to see a twofold recognition of the role private capital plays in growing companies and the economy.”

Carried interest is the percentage of an investment’s profit that a private equity partner or hedge fund manager takes as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is about 20 percent.

Under existing law, that money is taxed at a 20 percent capital gains rate for top earners. That’s about half the rate of the highest individual income tax bracket, which is 37 percent. A 2017 tax bill passed by Republicans left carry-rate treatment largely intact, after an intense lobbying campaign, but narrowed the exemption by requiring executives to hold on to their investments for at least three years to obtain a preferential rate. benefit from tax treatment.

An agreement reached last week by Senator Joe Manchin III, Democrat of West Virginia, and Senator Chuck Schumer, the Majority Leader, would have extended that three-year period to five years, while changing the way the period is calculated. in hopes of reducing taxpayers. opportunity to play the system and pay the lower tax rate of 20 percent.

But Ms. Sinema, who brought in political donations from wealthy financiers who usually donate to Republicans and was cool about the idea of ​​targeting last year, objected.

In the past five years, the senator $2.2 million in campaign contributions from investment industry executives and political action committees, according to Open Secrets. The industry was second to retirees in giving to Ms. Sinema and just ahead of the legal profession, which brought her $1.8 million.

For years, carry interest has been a tax policy piñata that never cracks open.

During the 2016 presidential campaign, Donald J. Trump said, “We will eliminate the carry-interest deduction, known deduction, and other special interest loopholes that were so good for Wall Street investors and people like me, but unfair to American workers.” .”

When President Biden ran for president in 2020, his campaign said: that he would “eliminate special tax breaks that reward special interests and close the loophole in capital gains for multimillionaires.” To do that, he said he would tax long-term capital gains at the ordinary top income tax rate, essentially wiping out the special treatment of carry interest.

A similar proposal appeared in Mr Biden’s budget last spring, but when Democrats tried unsuccessfully over the summer and fall to pass their “Build Back Better” legislation, interest disappeared.

Jared Bernstein, a member of the White House’s Council of Economic Advisers, lamented that the lobbyists had won.

“This is a loophole that absolutely must be closed,” said Mr Bernstein told CNBC last September. “If you go to Capitol Hill and start negotiating taxes, there are more tax lobbyists in this city than there are members of Congress.”

There are close ties between Democrats and the private equity sector in general. Michael Shapiro, a lawyer married to Mr. Schumer’s daughter, recently quit a job at the Department of Transport and joined giant investment firm Blackstone in June as director of government affairs.

“Senator Schumer has championed closing the loopholes in the Air Force for years and his support for it is unquestioned,” said Justin Goodman, a spokesman for Mr. Schumer. “He has worked to the end to try to keep the provision in the legislation and will continue to look for ways to eliminate it.”

Matt Anderson, a Blackstone spokesperson, said Mr Shapiro “will not be involved in advocacy for the Majority Leader or his office related to Blackstone activities.”

All along, some analysts were skeptical that lawmakers would actually change the carry-interest tax treatment in the final bill. While it has become a high-profile target, the change Democrats sought would have yielded relatively little tax revenue compared to other provisions in the legislation known as the Inflation Reduction Act.

“Carried interest has become the MacGuffin of the IRA saga,” said James Lucier, an analyst at Capital Alpha Partners, a Washington policy research firm, describing it as a literary tool authors use only to make plots more interesting. “The MacGuffin diverted attention from the really important things happening in the story to ultimately make the surprising conclusion even more surprising.”

Mrs. Sinema herself has said little about the legislation or why she finds it so important to maintain the tax deduction.

“We have agreed to remove the provision for tax-deferred taxes, protect advanced manufacturing and boost our clean energy economy in the Senate budget alignment legislation,” she said in a statement Thursday.