All during the 2016 campaign, President Trump talked about closing the carried interest loophole. Not once or twice, but multiple times. He derided it as a carve-out for a class of uber-wealthy private equity managers, saying they were “getting away with murder.” He promised when he was elected it would be closed. Even into 2017 there were promises from the White House that the carried interest loophole would be closed.
But it wasn’t closed in the Republican tax bill just enacted by the House and Senate — and it should be, for the benefit of all hardworking Americans who don’t benefit such a loophole. In fact, it easily can be closed, without Congress.
{mosads}While the idea of carried interest has been around for decades, the newest iteration of it began in 1993; the IRS gave an opinion on “realization events,” when real estate investments held for more than a year were deemed to be long-term capital gains. That opinion was also then applied to hedge fund and private equity (PE) firms, and that is the carried interest loophole that is being discussed. It allows PE firms to claim the money they gained off clients’ investments is actually investment as well, not profit.
Private equity works this way: The PE firms take an individual’s money and invest, say, $100,000 in the next greatest tech start-up in Silicon Valley. For managing the investment, the PE guys then take a 2 percent management fee. Whenever the individual’s money makes a return — say, $1,000,000 — the PE guys then get 20 percent of that return, or $200,000 of the individual’s investment.
Now to be clear, often the PE guys will put some of their own money into an investment, but typically not much, diminishing the risks they take with their own money. But when they take their 20 percent of the returns, they now claim that all of their return is investment income, not business income.
As Victor Fleischer points out, the PE managers want to be treated as investment partners, not the actual service providers that they are. They are acting as though they should be rewarded just the same as the real investor except, again, they typically put very little skin in the game — sometimes, not even a dime of their own money. For any returns on their actual money, that is investment income and should be taxed at a lower rate. But the rest of their returns made off other people’s money? That’s business income and should be taxed at the top rate.
But with the magic wand of carried interest, they get to treat all of their returns — most of which is real income — as long-term capital gains, meaning they only get taxed at a 20 percent rate (really 23 percent), not the 37 percent rate. That’s how the PE guys (like Steve Schwarzman of Blackstone Capital, making $400 million a year) get taxed at a lower rate than your average New York City cop making just over $85,000, as Trish Regan of FOX Business has pointed out.
What this also means is that the U.S. Treasury is losing, by some estimates, up to $180 billion in revenue over 10 years. Private equity is not a large sector; a very small, infinitesimal number of Americans work in it and are clearing that sum of money.
Now, there’s no problem with smart people making money. It’s just how does it square with someone making $85,000 getting taxed at a higher bracket, even with the new 2018 brackets? For example, that hardworking NYC cop, who is also getting dinged by the new caps on State and Local taxes (SALT)?
The SALT issue got dealt with in the tax bill, but not the carried interest loophole. There’s no moral or ethical grounds for it, no justification in it, except that the PE guys have greased the skids with Congress to make the sweetheart deal continue.
A search of Open Secrets shows that, in the 2016 cycle, congressmen, both Republicans and Democrats, received more than $14 million in political contributions from the Private Equity and Investment sectors. That includes 302 members of the House and 81 senators. If you were to look at the largest donors to the Senate Leadership fund of Senate Majority Leader Mitch McConnell (R-Ky.), you’ll see Steve Schwarzman of Blackstone giving more than $3 million in the 2016 cycle alone.
In reality, it’s all very simple as to why Congress won’t address the carried interest loophole: The duly elected supposed representatives of the people take in tens of millions of dollars for their re-elections, and then look the other way to allow the egregious system that enabled those funding their campaigns to rake in billions of dollars every year — again, primarily off other people’s investment monies. Those two parties walk away happy, and the American people get stuck with the bill.
And they do get stuck with the bill; someone always pays the bill for the other person getting the sweetheart deal. In this case, the hardworking wage-earners in America pick up for the lost revenue that now sits in the PE guys’ bank accounts.
So, despite Trump raising the issue in 2016, when the Tax Cuts and Jobs Act of 2017 occurred, Congress did nothing to address closing the carried interest loophole for private equity. Funny how it works in the swamp: Its denizens don’t want to bite the hand that feeds them.
In the grand scheme of things, $18 billion a year is a fraction of a fraction of the revenue brought in to the U.S. Treasury. But the carried interest loophole is a microcosm of why 2016 happened: The American people were sick of The Swamp, sick of the rigged system that benefitted a Ruling Class and their cronies, sick of officials who they had elected to represent them but who, instead, represent special interests.
What has made President Trump unique is that he has done what he said he would do. He works to keep his promises, and this is one he should keep.
The fact is that he can unilaterally act on the issue. This is good news for the likes of Gary Cohn, the president’s chief economic adviser, who claimed that, despite trying 25 times to get the carried interest loophole closed, Congress was simply unwilling to act.
Since the carried interest loophole for private equity is based on a nearly 25-year-old IRS opinion, Trump can circumvent the “swamp creatures” on the Hill and instruct Secretary of the Treasury Steve Mnuchin to ask for a new opinion on the matter from the IRS, one that says most of the PE returns are actually business income, not investment income, and that the PE guys are actually service providers, not partners. Then voilà, promise kept.
So Mr. President, fulfill your campaign promise. Do the morally right thing: Close the carried interest loophole.
Ned Ryun is a former presidential writer for George W. Bush and the founder and CEO of American Majority. You can find him on Twitter @nedryun.