Representatives Bill Pascrell (D-NJ), Andy Levin (D-Mich.) and Katie Porter (D-Calif.) have released legislation, H.R. 1068, that would increase taxes on carried interest capital gains. This legislation, known as the “Carried Interest Fairness Act,” should be rejected by members of Congress.
The tax treatment of carried interest capital gains is not a loophole but is grounded in several longstanding norms of the tax code. The effort to undo this tax treatment is not about “fairness,” but is about the progressive left’s goal of taxing all investment income as high as possible.
In fact, Democrats such as Rep. Pascrell and Senator Elizabeth Warren (D-Mass) recently pitched a tax hike on carried interest capital gains as a solution to the Gamestop-Robinhood controversy despite the fact that private equity had no role in this event and does not even invest in short term equities.
A tax increase on carried interest capital gains is bad policy that will harm the economy, threaten the retirement savings of Americans across the country, and fail to raise any meaningful revenue.
Carried Interest is a Mainstay of the Tax Code
Private equity is an investment class structured as a partnership agreement between an expert investor and individuals with capital. The tax treatment of the expert investor is known as carried interest capital gains. This tax treatment is grounded in two long-standing tax principles.
First, it is treated as partnership income, meaning taxation flows through to the individual taxpayers. In this case, carried interest is the investor’s share of partnership income they receive for providing expertise on investment decisions. All taxpayers involved in the partnership – those providing expertise and those providing capital – are taxed the same.
Second, it is treated as capital gains income as it is earned through long-term investment, not as ordinary income. Portfolio companies owned by private equity are held for a significant period of time, often 5 to 7 years. There is no justification for treating this as ordinary income – the investor purchased an asset, grew the asset by making it more economically valuable, and sold the asset at a profit – exactly the same as other types of investment.
Undermining either of these two principles undermines the existing tax code as a whole by opening the door to arbitrarily higher taxes on American savers and investors.
A Tax Increase on Carried Interest Could Harm Retirees & Savers Across the Country
Raising taxes on carried interest capital gains will not just harm private equity – it will also harm the millions of Americans that are saving for retirement.
Private equity seeks to invest in companies with growth potential and, as a result, has the potential to deliver strong returns. In fact, according to a recent study, private equity returned gains exceeding 15 percent over 10 years.
Because of these strong gains, private equity is a popular and reliable investment strategy for Americans across the country. The largest investor in private equity is public pension funds, which have collectively invested an estimated $150 billion in private equity. As noted by one study, 165 funds representing 20 million public sector workers have invested an average of 9 percent of their portfolios in private equity.
The financial security these returns provide to American savers including firefighters, teachers, and police officers will be threatened if lawmakers raise taxes on carried interest capital gains.
Increasing Taxes on Capital Gains Will Harm Economic Growth
Raising taxes on carried interest is just one part of the left’s goal to raise taxes on all investment. In fact, President Joe Biden has vowed to raise taxes on all capital gains to 43.4 percent, a tax hike that would harm the 53 percent of American households that own stocks.
It is widely accepted that taxes on capital gains – including taxes on carried interest capital gains – suppress growth and economic productivity, harm the creation of jobs and wages, and reduce other government revenue sources.
This same is true for carried interest – investment associated with carried interest capital gains drives significant economic growth across the country. Raising taxes on private equity investment will especially harm small businesses, innovators, and inventors that would find themselves increasingly shut out from investment money available to them from these partnerships.
A Tax Increase on Carried Interest Capital Gains Fails to Raise Meaningful Revenue
Not only is a tax hike on carried interest bad policy, it would fail to raise any significant revenue and is useless as a pay-for. In fact, taxing carried interest as ordinary income would raise just $14 billion over ten years, according to the Congressional Budget Office.
For context, the estimated price tag of Medicare for all is $32 trillion, while the price tag of the Green New Deal is at least $91 trillion. Carried interest is a drop in the bucket compared to these proposals.