Republicans in the U.S. Senate rolled out their version of a tax plan this week and left one controversial provision untouched: carried interest.
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Carried interest allows some hedge fund managers, venture capitalists and private equity financiers to pay a lower tax rate than average workers; that rate can dip as low as 20% when compared with the top bracket of 39.6%. They are able to use the carried interest tax break on the portion of the profit they take from their fund’s overall gains during a given year, which is typically 20%. While some see the provision as an incentive to encourage financial managers to take risks, others believe the profits are being made with clients’ money and should be treated as income rather than capital risk.
“Carried interest is a grey issue because it’s … partly capital gains and partly labor income,” Chris Edwards, director of tax policy studies at the Cato Institute and editor of www.DownsizingGovernment.org, told FOX Business. “A lot of people are cynical about the role of private equity and venture capital … in the economy, but it plays a crucial role. I would hesitate getting rid of it, but I wouldn’t be totally against it.”
Then-candidate Donald Trump said during the campaign he wanted to close the loophole, criticizing some hedge fund managers for “getting away with murder” where the provision is concerned. National Economic Director Gary Cohn said as recently as September that the president was committed to eliminating the loophole.
“A lot of what Trump has wanted is in these bills, so his administration is having a lot of influence,” Edwards said. “So it is very surprising [carried interest is not included].”
While GOP senators shied away from outright removing the loophole, the plan put forward by the House of Representatives would slightly amend it, delaying the so-called “holding period” from one year to three years. That means a hedge fund would have to hold an asset for three years in order to receive the lower tax rate on gains. Edwards said this could be a good compromise because it distinguishes between short-term and long-term capital gains, where the latter is generally favored by the government because it is more often associated with pro-growth activity.
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Treasury Secretary Steven Mnuchin spoke to FOX Business about the carried interest provisions in both bills on Friday, refusing to comment on whether he viewed carried interest as investment or income, saying instead that discussions on the issue would continue in Congress.
Edwards also said that the final bill could ultimately address carried interest in a different way as negotiations progress. He would only like to see it eliminated if the government were to “use the money to reduce other taxes on corporations or capital gains, … [using] the money to reduce taxes to spur growth in other ways.”