Bills
| 3.23.22

Eliminating Tax Advantages for Investment Fund Managers (S. 781)

Do you support or oppose this bill?

What is S. 781?

(Updated April 4, 2020)

This bill would reform the tax code by requiring managing partners (big wigs) at hedge funds and private equity firms to pay income taxes rather than long-term capital gains taxes as they earn money from “carried interest.” Basically, higher taxes than they're used to.  

What's carried interest you ask? Current law allows investment funds to be structured as a partnership by the managers, who may invest in the business and keep some of the fund’s profits as compensation. 

When the fund’s profits are long-term capital gains from investments, managers pay capital gains taxes — either 15 or 20 percent — rather than ordinary income taxes which may be up to 39.6 percent depending on their income level.

This legislation would require the carried interest income of managing partners be taxed as ordinary income rather than a capital gain. Penalties for underpayment would be increased. The bill would apply to any member of a partnership that provides the following services:

  • Advising the partnership about investing in, purchasing, or selling specific assets;
  • Managing, acquiring, or disposing of the partnership’s assets; and
  • Arranging financing related to acquiring those assets.

Argument in favor

The carried interest loophole benefits the wealthiest, most politically connected Americans who use it to pay a lower effective tax rate than many ordinary hard-working Americans. Managing partners at hedge funds and private equity firms need to pay their fair share of taxes.

Argument opposed

It would set a bad precedent for Congress to enact policy targeting the compensation system of one particular industry to score political points. Plus it would be of little fiscal benefit, as $1.5 billion annually in new tax revenue doesn’t help much with a budget deficit that tops $500 billion.

Impact

Managing partners at hedge funds or private equity firms; and the IRS.

Cost of S. 781

A CBO cost estimate is unavailable. However, the CBO estimates that closing the carried interest loophole would raise $14 billion in revenue over 10 years.

Additional Info

In-Depth: Sponsoring Sen. Tammy Baldwin (D-WITH) reintroduced this bill from the 115th Congress to close what she referred to as the “carried interest loophole” and ensure that investment fund managers pay more in taxes:

“President Trump broke his promise to close the carried interest tax loophole that benefits money managers on Wall Street and the top one percent. I want to see loopholes closed — like the one that favors Wall Street hedge funds and allows them to pay a lower tax rate than many Wisconsin workers. It’s simply unfair for our workers to pay a higher tax rate than a millionaire on Wall Street, so President Trump needs to stand by his word, support our legislation and finally close the carried interest tax loophole for Wall Street.”

Rep. Bill Pascrell (D-NJ), sponsor of this bill's House companion, adds: 

“Certain wealthy taxpayers should not have their own parallel tax code of special breaks and deductions. Our system has always been based on the principle that we ask more from those who have more, but today private-equity investors can pay a lower tax rate than their secretaries. Building on the work of my esteemed former colleague Sandy Levin, this new Congress will fight to put fairness back at the center of our nation’s tax policy. Millions of Americans filing their taxes are finding that the refunds they anticipated will not materialize this year. They and many other Americans are rightly outraged at a tax code that is badly skewed to favor some of our wealthiest citizens and corporations.”

When she introduced this bill last Congress, Sen. Baldwin argued that it was needed to keep President Trump true to his word to close the carried interest loophole:

“If President Trump is in fact serious about closing the carried interest tax loophole for hedge fund managers on Wall Street, we are introducing legislation to do just that and we welcome his support so he can keep the promise he has made. With his one-page tax proposal that gives massive tax cuts for millionaires and billionaires, I am afraid President Trump is breaking his promise and is engaging in a classic Washington game of bait-and-switch. He needs to stand by his word to close the carried interest tax loophole and support our legislation.”

The Communications Workers of America (CWA) supports this bill. In a press release, its president, Chris Shelton, says: 

"For years, the carried interest tax loophole has allowed some of the wealthiest people in this country to pay a lower tax rate than millions of middle-income workers. Meanwhile, our country's infrastructure is crumbling, our young people struggle to pay college tuition, and critical programs like Social Security and Medicare are constantly under threat. It's time to close the carried interest loophole and make Wall Street pay its fair share."

The American Investment Council, which opposes this bill, argues that it constitutes a "discriminatory tax increase" on the private equity industry. The conservative Heritage Foundation argues that increasing taxes on investment "is always a bad idea": 

"The Carried Interest Fairness Act of 2019 is simply the regurgitation of a talking point that has been around for more than a decade: Hedge fund billionaires are gaming the system to screw the little guy. This year, we can simply add it to the pile of proposals to further increase taxes on the “rich,” those who already pay the lion’s share of income taxes. Closing the so-called carried interest loophole means increasing taxes on investment managers, real estate developers, and other investment partnerships. The overheated rhetoric used by reformers claims the lower tax rate is “one of the most egregious loopholes in the federal tax code.” Like most things in tax policy, they dramatically overstate and oversimplify the issue... Our tax code’s built-in bias against saving for the future is partially mitigated by having a lower tax rate on capital gains and dividends. The top rate on investment earnings is 20 percent in contrast to the top income tax rate of 37 percent. This is a pro-growth feature of our tax code, not a loophole. Whether or not you think carried interest is different than a traditional capital gain ultimately comes down to what you think the difference is between wage and investment income—a blurry line that is only necessary in our poorly structured income tax regime. In a report from 2007, Stuart Butler, then-Heritage Foundation economic policy director, described how new taxes on investment 'would not only threaten the economy generally[,] but would also jeopardize a particularly important and crucial part of the entrepreneurial economy: capital-intensive firms that take the risk of investing in and restructuring underperforming enterprises and putting them onto a sound footing.' For those looking for new tax revenue, it is important to remember that in the grand scheme of the U.S. tax code, carried interest is small potatoes. It would raise very little revenue with potentially large economic costs."

When this bill was introduced in the 115th Congress, an op-ed opposed to it in the Washington Examiner argued that ending the treatment of investment income from partnerships as capital gains and taxing it instead at ordinary income tax rates would result in "lost economic opportunity" exceeding the tax revenue this bill would bring in. It included the following summation from a former Heritage Foundation executive who moved on to the Brookings Institution:

"This tax hike would not only threaten the economy generally. It would also jeopardize a particularly important and crucial part of the entrepreneurial economy -- capital-intensive firms that take the risk of investing in and restructuring underperforming enterprises and putting them onto a sound footing."

The National Law Review predicts that this bill's odds of passage in a divided Congress are "quite low," as Senate Republicans are unlikely to pass it. However, should the bill pass, the National Law Review is unsure about how it'd fare with the president, as President Trump has made statements criticizing private equity and hedge fund managers' compensation and taxation.

This legislation is cosponsored by 13 Democratic senators in the 116th Congress. A House companion, sponsored by Rep. Bill Pascrell (D-NJ), has 28 Democratic House cosponsors in the current Congress. 

Last Congress, this bill had 13 Democratic Senate cosponsors and didn't receive a committee vote. The House companion bill, sponsored by Rep. Sander Levin (D-MI), had 40 Democratic House cosponsors and also didn't receive a committee vote.

In the current Congress, this bill has the support of the AFL-CIO, Americans for Tax Fairness, American Federation of Government Employees, American Federation of State County and Municipal Employees, American Federation of Teachers, Americans for Financial Reform,  Communications Workers of America, Patriotic Millionaires, Public Citizen, U.S. Public Interest Research Group, Working America, and Take on Wall Street, which is a coalition of over 50 groups including unions, community organizations, faith groups, environmental groups, consumer advocates, democracy advocates, economic and racial justice advocates and researchers, and more.

Of Note: According to an estimate by the Joint Committee on Taxation, this bill’s identical House companion would lead to $15.6 billion in new federal income tax revenue over the 2016-2025 period. It projects that tax revenue from carried interest would peak in 2018 at nearly $2.1 billion before declining to just over $1 billion in 2025.

The carried interest loophole allows hedge fund and private equity fund managers to claim part of their compensation income as capital gains instead. Thus, they pay about 20% in taxes on that income — a lower rate than that paid by many middle-class workers whose incomes are taxed at personal income rates for the full amount.


Media:

Summary by Eric Revell
(Photo Credit: Flickr user Eric Skiff)