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Carried Interest Doesn’t Deserve a Special Tax Break

The private equity industry has descended on Capitol Hill to preserve the lower tax rate for something known as “carried interest,” as compared to the tax rate Americans normally pay on the income they earn.   While many interest groups try to convince lawmakers that they deserve special treatment, the proponents of this lower tax rate make a particularly unconvincing case.

Carried interest is the share of a private equity fund’s profits that a fund manager can receive, without having to contribute a corresponding share of the fund’s capital.

The issue is whether the federal government should continue to tax carried interest at the same rate as capital gains (currently 15 percent) or adopt the higher rate imposed on ordinary income (currently up to 35 percent).  The tax extenders bill before the House would ultimately tax three-quarters of carried interest as ordinary income.

A basic tenet of tax policy is that compensation for services rendered should be taxed as ordinary income, not capital gains, and carried interest seems to fall into that category.  As the Blackstone Group, a leading private equity firm, stated in a filing with the Securities and Exchange Commission: “the primary source of income from each of our businesses is properly characterized as income earned in exchange for the provision of services.”  One of our former colleagues made a compelling case as well.

Also, there’s no logical reason why a leveraged buyout (LBO) specialist at a private equity firm should be taxed differently than a mergers and acquisitions expert at an investment bank (who pays as much as 35 percent in taxes), since both people are doing basically the same kind of work.

Venture capital funds — private equity funds that invest in start-up businesses — argue that changing the tax treatment of carried interest would hurt them and thus the economy.  But it’s hard to believe that the people working to find the next Apple or Microsoft are doing it just because of a tax shelter and would quit rather than be taxed like everybody else.

Especially when you consider the huge deficits this nation faces, closing the carried interest loophole is both fair and sensible.

Chuck Marr
Vice President for Federal Tax Policy