During the South Carolina Republican debate, Governor Jeb Bush was asked to defend his proposal to tax carried interest capital gains as ordinary income.
Bush incorrectly claimed that carried interest allows investors special treatment under the tax code. As Bush argued:
“It’s not the end of the world that private equity people and hedge fund folks that are, right now, getting capital gains treatment for the income they earn, pay ordinary income like everybody else in this room.”
There is a widespread misconception that treating carried interest as capital gains is a loophole. But the truth is carried interest is identical to all other capital gains and should be treated no differently.
Carried interest is the share of an investment partnership allocated to the investor. These partnerships occur when individuals with capital and individuals with expertise pool their resources together.
“Hedge fund folks” don’t have some special deal — they pay the same capital gains rates as everyone else. All income from a partnership is derived from a long-term investment in a business or real estate and so all income is treated as a capital gain.
The bottom line is there is zero difference between carried interest and any other type of capital gain.
Indeed, no Republican candidate should push taxing carried interest capital gains as ordinary income. It is not a loophole in any way and should be treated the same as all other capital gains.