Rep. Bill Pascrell Jr. (D-N.J.), right, has proposed legislation taking aim at the capital gains tax rate enjoyed by US fund managers. (Chip Somodevilla/Getty Images)
It’s been more than 10 years since then-President Barack Obama first proposed ending the carried interest tax break, a provision that allows top earners from private equity and hedge funds to pay a smaller percentage in federal income tax than other Americans.
With Democrats now in control of both chambers of Congress and the presidency, legislation to close the loophole and increase the tax burden for investment managers is back on the agenda.
Earlier this week, a group in the US House of Representatives led by Bill Pascrell Jr. (D-N.J.), chairman of the House Ways and Means oversight subcommittee, introduced a bill that would tax profits made by investment fund managers as ordinary income, or as high as 37%, rather than as capital gains, which are taxed at 15% to 20%. Reps. Andy Levin (D-Mich.) and Katie Porter (D-Calif.) also sponsored the legislation.
“Over the last four years, our tax system has continued to become more unfair,” Pascrell said in a statement. “Our two-tier tax code, with one code for working class Americans, and another full of special breaks for the people at the very top, has destroyed public confidence in our tax structure that must be restored.”
It’s an early answer to the question of what a Democrat-controlled Congress might mean for private equity. Venture capitalists are also watching closely to see what the next two years may bring.
Dubbed the Carried Interest Fairness Act of 2021, or HR 1068, the bill would allow fund managers who put their own money in a fund—a common practice in private equity—to still treat those profits as capital gains. However, income earned from managing a firm’s assets would be treated as regular income and taxed at the higher rate.
The American Investment Council, a trade organization that represents private equity firms, strongly opposes the latest legislation, which the Congressional Budget Office estimates could raise $14 billion over the next decade.
“The 2017 tax law made sure that investors only realize long-term capital gains (on) carried interest after investing in a company for over three years,” AIC president Drew Maloney said in a statement. “As workers and local economies continue to struggle during this pandemic, this would be the worst time for Washington to reverse this responsible policy and punish long term investment that creates jobs and builds businesses in communities across America.”
The current carried interest framework was established in 1954, in part to spur investment in oil speculation. In more recent decades, though, it has become synonymous with private equity, hedge funds and other major investors, sparking critiques from across the political spectrum. Several years after Obama proposed changing carried interest taxation in 2010, Donald Trump also promised to end the current treatment during his 2016 presidential campaign.
The tax plan Trump ultimately implemented in 2017 didn’t go that far, but it did force fund managers to hold portfolio companies for at least three years instead of one before they could receive the lower capital gains treatment. The plan also reduced the percentage of debt managers could write off for their portfolio companies. Even so, Trump said in a 2019 interview that he wished he could have closed the loophole but ultimately relented in exchange for dropping the corporate tax rate to 21%.
This isn’t Pascrell’s first attempt at changing the tax code. In 2019, he introduced the Carried Interest Fairness Act, but it failed to get out of committee. When assessing the role of private equity that same year, lawmakers on both sides of the aisle praised private equity firms for creating jobs in their respective districts.
Time will tell whether his latest effort is more successful.
“Our system always been based on the principle that we ask more from those who have more,” Pascrell said. “The carried interest loophole has allowed private equity tycoons to pay lower tax rates than their secretaries. This year, millions of Americans are struggling to survive and are entitled to a fairer tax system. This loophole has survived too long, and we are going to push hard to see that it is finally closed.”