Finance

The Carried Interest Loophole Survives Another Political Battle

WASHINGTON — Once again, carried interest carried the day.

The last-minute removal by Senate Democrats of a provision in the climate and tax legislation that would narrow what is often referred to as the “carried interest loophole” represents the latest win for the private equity and hedge fund industries. For years, those businesses have successfully lobbied to kill bills that aimed to end or limit a quirk in the tax code that allows executives to pay lower tax rates than many of their salaried employees.

In recent weeks, it appeared that the benefit could be scaled back, but a last-minute intervention by Senator Kyrsten Sinema, the Arizona Democrat, eliminated what would have been a $14 billion tax increase targeting private equity.

Lawmakers’ inability to address a tax break that Democrats and some Republicans have called unfair underscores the influence of lobbyists for the finance industry and how difficult it can be to change the tax code.

In addition to doing away with the carried interest provision, the deal Democratic leaders cut with Ms. Sinema included a 1 percent excise tax on stock buybacks and changes to a minimum corporate tax of 15 percent that favored manufacturers.

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

“The private equity industry directly employs over 11 million Americans, fuels thousands of small businesses and delivers the strongest returns for pensions,” said Drew Maloney, the chief executive of the American Investment Council, a lobbying group. “We encourage Congress to continue to support private capital investment in every state across our country.”

Bryan Corbett, the chief executive of the Managed Funds Association, said: “We’re happy to see that there is bipartisan recognition of the role that private capital plays in growing businesses and the economy.”

Carried interest is the percentage of an investment’s gains 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 capital-gains rate of 20 percent for top earners. That’s about half the rate of the top individual income tax bracket, which is 37 percent. A tax law passed by Republicans in 2017 largely left the treatment of carried interest intact, after an intense lobbying campaign, but it did narrow the exemption by requiring executives to hold their investments for at least three years in order to enjoy preferential tax treatment.

An agreement reached last week by Senator Joe Manchin III, Democrat of West Virginia, and Senator Chuck Schumer of New York, the majority leader, would have extended that holding period to five years from three, while changing the way the period is calculated in hopes of reducing taxpayers’ ability to take advantage of the lower 20 percent tax rate.

What’s in the Climate, Health and Tax Bill


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A new proposal. The $370 billion climate, tax and health care package that Senate Democrats passed on Aug. 7 could have far-reaching effects on the environment and the economy. Here are some of the key provisions:

Auto industry. Currently, taxpayers can get up to $7,500 in tax credits for purchasing an electric vehicle, but there is a cap on how many cars from each manufacturer are eligible. The new bill would eliminate this cap and extend the tax credit until 2032; used cars would also qualify for a credit of up to $4,000.

Energy industry. The bill would provide billions of dollars in rebates for Americans who buy energy efficient and electric appliances. Companies would get tax credits for building new sources of emissions-free electricity. $60 billion is set aside to encourage clean energy manufacturing and penalties for methane emissions that exceed federal limits starting in 2024.

Health care. For the first time, Medicare would be allowed to negotiate with drugmakers on the price of some prescription medicines. The bill would also extend subsidies available under the Affordable Care Act, which were set to expire at the end of the year, for an additional three years.

Tax code. The bill would introduce a new 15 percent corporate minimum tax on the profits companies report to shareholders, applying to companies that report more than $1 billion in annual income but are able to use credits, deductions and other tax treatments to lower their effective tax rates. The legislation would bolster the I.R.S. with an investment of about $80 billion.

Low-income communities. The bill would invest over $60 billion to support low-income communities and communities of color that are disproportionately burdened by climate change. This includes grants for zero-emissions technology, as well as money to mitigate the negative effects of highways and other transportation facilities.

Fossil fuels industry. The bill would require the federal government to auction off more public space for oil drilling and expand tax credits for coal and gas-burning plants that rely on carbon capture technology. These provisions are among those that were added to gain the support of Senator Joe Manchin III, Democrat of West Virginia.

West Virginia. The bill would also bring big benefits to Mr. Manchin’s state, the nation’s second-largest producer of coal, making permanent a federal trust fund to support miners with black lung disease and offering new incentives to build wind and solar farms in areas where coal mines or coal plants have recently closed.

But Ms. Sinema, who has received political donations from wealthy financiers who usually donate to Republicans and who was cool to the idea of targeting carried interest last year, objected.

In the past five years, the senator has received $2.2 million in campaign contributions from investment industry executives and political action committees, according to OpenSecrets, a nonprofit group that tracks money in politics. The industry was second only to retired individuals in giving to Ms. Sinema and just ahead of the legal profession, which gave her $1.8 million.

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

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

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

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

Jared Bernstein, a member of the White House’s Council of Economic Advisers, lamented that outcome. “This is a loophole that absolutely should be closed,” Mr. Bernstein told CNBC last September. “When you go up to Capitol Hill and you start negotiating on taxes, there are more lobbyists in this town on taxes than there are members of Congress.”

Ms. Sinema has long been a defender of the private equity industry, going back to her time in the House. In recent weeks, representatives from small business, venture capital and the renewable energy sector blanketed Ms. Sinema and her staff with information about their presence in and importance to Arizona, according to a lobbyist familiar with the effort.

“Senator Sinema makes every decision based on one criteria: what’s best for Arizona,” said her spokeswoman, Hannah Hurley.

The American Investment Council said that venture capital and private equity firms invested $67 billion in Arizona from 2016 to 2020, and that businesses backed by private equity employ nearly 230,000 workers in the state. Several prominent private equity firms, like Blackstone, KKR and Warburg Pincus own businesses in the state.

Executives of some of those firms have made campaign contributions to Ms. Sinema, including George Roberts, Henry Kravis and Joseph Bae at KKR and Sean Klimczak and Eli Nagler at Blackstone.

Opinions on the carried interest tax treatment vary even within the financial industry. In posts on Twitter in late July, Bill Ackman, the founder of Pershing Square Capital Management, a New York hedge fund, said that while “favorable tax treatment” for the founders of new businesses was essential, people who manage funds that own many companies should not be entitled to the same benefit.

“The carried interest loophole is a stain on the tax code,” he wrote in one post. “It does not help small businesses, pension funds, other investors in hedge funds or private equity and everyone in the industry knows it. It is an embarrassment and it should end now.”

Some analysts were skeptical all along that lawmakers would actually change the carried interest tax treatment in the final bill. While it has become a high-profile target, the change Democrats were seeking would have raised little tax revenue compared with other provisions in the legislation, known as the Inflation Reduction Act.

“Carried interest has become the MacGuffinof the I.R.A. saga,” said James Lucier, an analyst at Capital Alpha Partners, a policy research firm in Washington, describing it as a literary device that authors include merely to make plots more interesting. “The MacGuffin distracted attention from the really important things going on in the story to make the startling conclusion even more surprising in the end.”

On Friday, some progressive policy experts shrugged off the elimination of the carried interest provision, which they considered only a modest improvement over current law.

“The proposal that was in the bill until last night made a technical adjustment in the holding period for assets that qualified for carried interest treatment,” said Jean Ross, a senior fellow at the Center for American Progress, a liberal research group in Washington. “A better approach would tackle the issue head-on and say that compensation for services managing an investment fund should be taxed like work and subject to ordinary tax rates.”

Ms. Ross added that she was pleased by the addition of the tax on stock buybacks, which some Democrats and their allies have long supported, arguing that companies are spending too much money buying back their own shares, rather than investing in research and development or giving workers raises.

Ms. Sinema herself has said little about why she considered it so important to preserve the carried interest tax treatment. She has said that she plans to work on legislation with Senator Mark Warner, Democrat of Virginia, to address the loophole. But if the legislation is not included in the current package, which is being fast-tracked under an arcane budget process, any reform will require support from at least 10 Republicans.

“I think we reached agreement that there are areas where there’s been abuse,” Mr. Warner said in an interview, adding, “I’m disappointed it didn’t get in this bill, but I’m looking forward to working with Senator Sinema — and others — to see if we can address this.”

In a statement on Thursday, Ms. Sinema said, “We have agreed to remove the carried interest tax provision, protect advanced manufacturing and boost our clean energy economy in the Senate’s budget reconciliation legislation.”

Emily Cochrane contributed reporting.

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