Carried interest: a taxing argument
15 April 2013
Posted by: Author: Financial Times Limited
Source: Financial Times Limited
Is private equity being unfairly singled out?
How do you know when you’ve won an argument? When your opponent changes the subject. That is the current status in the controversy over the tax treatment of "carried interest” in the US. Carried interest is the portion of profits from investments that private equity and hedge fund managers keep for themselves. It is currently taxed at the lower capital gains rate of up to 20 per cent.
The rub is that the managers have only contributed effort – and not their own capital – to the making of those profits. Plenty of professions offer variable compensation based on a happy outcome: tips for delivering pizzas, say. But delivery drivers must still pay the ordinary income tax rate. The industry and its apologists can’t explain the justice in this paradox, so they do not even try. Instead, they resort to bromides about risk-taking, entrepreneurship, apple pie and George Washington.
Investors in the units of publicly traded private equity groups such as Blackstone, Carlyle and KKR may wonder if their fund managers will work as hard to generate returns under a tougher tax regime. But one does get the strong sense that private equity is being unfairly singled out (perhaps because of hapless candidate Mitt Romney).
The Congressional Budget Office estimates that plugging the carry loophole would generate just $21bn over 10 years, against deficits of more than $5tn in that time. But when the debate centres exclusively on private equity it ignores other tax-advantaged structures such as Real Estate Investment Trusts (Reits) and Master Limited Partnerships (MLPs), which are designed to shield income at the corporate level.
At the investor level, the justification for preferred treatment for capital gains must also be reconsidered in an era of overflowing red ink and stagnant incomes for the average worker.