As the American economy plunges into a recession, Senate Majority Leader Chuck Schumer (D-N.Y.) and Senator Joe Manchin (D-W.Va.) are proposing to apply a $14 billion tax on private investment funds, which will reduce pension fund returns, disincentivize real estate investment, and exacerbate job losses.
Instead of cutting spending and reducing taxes to pay down the national debt and promote a balanced budget, the misnamed Inflation Reduction Act will increase taxes and spending by hundreds of billions of dollars. In particular, the bill will increase the tax rate on private funds (e.g., private equity, venture capital, and real estate partnerships) that manage trillions of dollars of retirement money. This comes on the heels of a U.S. economy that has been contracting for two consecutive quarters and is suffering through exorbitantly high inflation.
The Schumer-Manchin tax bill parts ways with how general partnerships are properly taxed. The bill increases the top tax rate for general partners of private funds from 20 to 37 percent (not including an additional net investment income tax and state taxes). The nonpartisan Congressional Budget Office has admitted that taxing “carried interest” as income instead of capital gains “would treat general partners of investment funds differently from general partners in other industries.”
The partisan bill would increase the amount of time assets must be held to qualify for long-term capital gains rates. Democrats would extend the holding period for carried interest to five years. This is significantly longer than the one-year holding period that is required for assets like stocks and bonds to qualify for long-term capital gains rates.
The bill would also change the start of the holding period from the point when a firm makes its first investment to an ill-defined point when a firm makes “substantially all” of its investment. The change adds significantly more complexity to the tax code, but the goal is clear–make it more difficult for firms to qualify for long-term rates.
Democrats are making this change because they believe targeting Wall Street will be politically popular. But this greatly underestimates the reach of the tax hike. Now more than ever, pension fund managers are choosing to invest retiree’s pension money in private fund investments. According to the Wall Street Journal, about one quarter of state and local pension fund assets ($1.25 trillion) are invested in private equity, real estate, hedge funds, and private debt funds. There is “$480 billion in public-worker retirement money” invested in private equity—a 60 percent increase since 2018.
Private equity has also elevated teachers’ retirement funds. In the first quarter of this year, the Pennsylvania Public School Employees’ Retirement System “significantly outperformed the average of large public pension funds” because of “its use of alternative investments such as private equity.”
Under the new tax rate, pension funds will lose money. A U.S. Chamber of Commerce report explains that public pension funds “may lose up to $3 billion annually since they would need to switch some of their investments into lower-yielding investments.” Private funds will be forced to downsize by nearly 20 percent, which will reduce returns to investors “by the same amount.”
Private funds and their portfolio companies employ millions of Americans and provide hundreds of billions of dollars in tax revenue to federal, state, and local governments. According to the U.S. Chamber report, these private funds, and their portfolio companies “account for over 25 million American jobs and provide an annual estimated combined federal, state, and local tax revenues of over $493 billion.” The report found that an increase in the tax rate on carried interest, such as the one in the Schumer-Manchin tax bill, could lead to 4.9 million job losses in the long-term and net revenue losses of $96 billion.
A tax increase on carried interest also negatively affects real estate investment. At a time when the U.S. is facing a severe housing shortage, the Schumer-Manchin tax bill plans to raise taxes on real estate partnerships, which will make “partners less inclined to provide effort and attract investors to acquire or build real estate.” Less investment in commercial, industrial, and residential buildings, combined with the Federal Reserve raising interest rates, will only make housing more expensive for renters and homeowners—contributing to a spike in rent prices and mortgage payments.
The Schumer-Manchin tax bill’s description of this provision as “closing the carried interest loophole,” is no more than a wolf in sheep’s clothing. Taxing private funds at a time when the economy is contracting will only contribute to more job losses, poor pension fund returns, and disincentivize investment.