People who make between $40,000 and $85,000 per year pay a top federal income rate of 22%. Anyone who makes more, pays more — except billionaire private equity managers.
Here is how it works. Private equity firms buy up other companies, do whatever they can to increase their value, and then try to take them public or sell them at a profit. The managers of private equity funds, known as general partners, receive a share of the profit (usually around 20%) as payment for managing the money in the private equity fund. This cut of the profits is known as "carried interest."
For example, in 2015, Stephen Schwarzman, the billionaire co-founder of the private equity firm Blackstone, collected $88.3 million in carried interest. If he was in any other profession Schwarzman would pay the top income tax rate on virtually all of that money, which at the time was 39.6% (and is 37% today). But, because Schwarzman is a hedge fund manager, that $88.3 million is considered "long-term capital gains" and is taxed at a top rate of about 23%. That means Schwarzman's tax bill in 2015 on his carried interest was reduced from $35 million to $20.3 million, saving Schwarzman about $15 million.
Schwarzman does not need this tax break. As of 2020, he had a personal fortune of $17.7 billion, making him the 29th richest person in the world. Many other millionaires and billionaires who manage private equity enjoy the same tax benefits.
The Biden administration is proposing a range of new programs to support working families including paid family leave, universal pre-K, and an expansion of the child tax credit. It would be paid for, in part, by closing the carried interest loophole for private equity managers. That change would generate $17 billion in revenue over 10 years.
Schwarzman would still be a billionaire. But the government would have billions in more revenue to support working families. Seems like a no-brainer?
Donald Trump thought so when he was running for president in 2016. He ran on a pledge to eliminate the carried interest loophole. The New York Times called it "a signature promise that helped propel his populist presidential campaign." But faced with an intense lobbying effort from business groups, Trump folded and dropped a fix for the carried interest loophole from his 2017 tax law.
Today, the same monied interests are gearing up again to maintain special treatment for billionaires.
The U.S. Chamber of Commerce's hysterical argument
The public face of the effort to maintain the carried interest loophole is the U.S. Chamber of Commerce, the powerful lobbying group that represents nearly every major American company.
The Chamber produced a report which claims that eliminating the carried interest loophole for private equity managers would result in the "loss of 4.9 million jobs within five years across the United States." Intuitively, this makes no sense. That's as many jobs as there are in the entire state of Georgia. If Schwartzman paid a higher tax rate on his share of carried interest, why would anyone lose their job?
Indeed, tax experts scrutinized the Chamber's analysis and found a number of flaws. Closing the carried interest loophole will only impact the compensation of private equity managers. It does not impact the profitability of the activity for ordinary investors. In all likelihood, most private equity managers will keep doing exactly what they are doing and pay somewhat higher taxes.
The Chamber's study assumes that there will be less private equity activity overall, the private equity firms will downsize and fewer companies will have access to private equity capital. These companies, the study assumes, won't be able to get capital anywhere else, will have to shut down and fire everyone. And the people who are fired from these companies will not get new jobs. The study also assumes that the private equity investment that continues will be more risk averse due to the higher tax rate.
None of these assumptions make sense. That's why Victor Fleischer, a tax law professor at UC Irvine, calls the Chamber study "bogus" and argues there is "no reason to expect any job loss" from closing the carried interest loophole. Corey Husak of the Center for Equitable Growth says the study "ignores simple [economic] concepts to pretend closing a millionaire loophole hurts real people." Senator Ron Wyden (D-OR) said the study was "insulting to the intelligence of every American.”
The rich dodge billions in taxes
The carrier interest tax loophole is a legal way that private equity managers avoid paying their fair share of taxes. But the richest 1% of Americans also fail to pay billions in taxes they owe under the law.
A study released Wednesday by the Treasury Department details the "tax gap" — the difference between how much Americans pay in taxes and how much they owe. Overall, the tax gap amounts to $600 billion each year. The top 1% of earners alone skip out on $163 billion in taxes annually. The rich can get away with it because the IRS is understaffed and under-resourced. In recent years, the IRS has devoted a large percentage of its audits on very low-wage workers.
"Today’s tax code contains two sets of rules: one for regular wage and salary workers who report virtually all the income they earn; and another for wealthy taxpayers, who are often able to avoid a large share of the taxes they owe," the study concludes.
The Biden administration is proposing paying for family leave and other programs in its reconciliation package, in part, by beefing up IRS resources. It estimates that an $80 billion investment in the IRS, combined with enhanced disclosure from financial institutions, could yield $700 billion in new tax revenues over the next decade by forcing more wealthy people to pay what they owe.
"Republicans in Congress and lobbyists for business are united in opposition to the proposal to shore up tax enforcement," the Guardian reports.
The carried interest loophole is a great topic for discussion because it helps lay bare how broken the U.S. tax system is. There should be broad agreement across the political spectrum that taxes on the richest Americans should be raised and, with that, enforced. The "private equity firms are the real job creators" line that the Chamber of Commerce is pushing is more trickle-down nonsense that Democrats should pushing back against with force.
Income is income, regardless of source. For personal tax purposes, there should be no special brackets or treatment. No matter how much you made, from $1 to $1,000,000,000 and up, there should be a single income line on the tax form and the taxpayer should add everything up--interest, dividends, capital gains, winnings or wages--and put the total on that line. Exemptions? Sure. Deductions? Okay, but they phase out above a certain income level.
Eliminate all the special classes of income and we could reduce the marginal rates and still increase tax revenue. And it makes it that much harder for the super-rich to cheat by eliminating possibilities.