(Bloomberg) One of the Democratic Party’s favorite applause lines is getting another turn in the spotlight: hit hedge-fund millionaires with the same taxes as the working class.
It still works on the stump even though it has fallen short in the Capitol. Lower tax rates on carried interest have fewer defenders now, even among Republicans. Democrats haven’t been able to muster the votes to change the rules, despite almost a decade of trying.
The politics are hard, but the math is simple. The top rate for wage earners is 43.4 percent. Many investment managers pay taxes at a 23.8 percent top rate, because their gains are counted differently in the tax code.
President Barack Obama criticized this disparity in 2007. So did Hillary Clinton. And now they’re back as they shape their party’s populist agenda on income inequality.
Obama on Tuesday used some of his strongest language yet, reminding an audience at Georgetown University that Stephen Schwarzman of Blackstone Group LP once compared the president’s tax policies on his industry to Adolf Hitler’s invasion of Poland. He later apologized.
“The top 25 hedge fund managers made more than all the kindergarten teachers in the country. So when I say that, I’m not saying that because I dislike hedge fund managers or I think they’re evil,” Obama said at a forum on poverty. “If we can’t ask from society’s lottery winners to make that modest investment, then really this conversation is for show.”
No Consensus
As Obama nears the end of his presidency, the talk about higher taxes on carried interest has yielded a consensus that something will change—and uncertainty on just what and when.
“We in a very broad way won the substantive argument,” said Jeff Ziarko, who helped write legislation to impose higher taxes on carried interest as an aide to Representative Sander Levin, a Michigan Democrat. “The politics just haven’t sorted out yet.”
Those politics are the result of a well-funded industry campaign to tout the benefits of private equity and the bottleneck in Congress on significant tax legislation. The Private Equity Growth Capital Council, a trade association whose members include KKR & Co. and Silver Lake Management, has spent more than $21 million lobbying since it started in 2007, according to Senate records.
If and when U.S. lawmakers revamp the tax system—a prospect that still could be years away—carried interest will be on the table. Until then, it will be a hard sell with Republicans in control of the U.S. House and Senate.
Not Interested’
“Republicans in Congress are interested in doing broad tax reform and are not interested in one-off revenue raisers,” said Warren Payne, who was policy director for former Ways and Means Chairman Dave Camp, a Republican who proposed taxing some carried interest as ordinary income. “That was only something folks were willing to do because we were also lowering rates.”
Carried interest is the profits interest that private equity managers receive in the companies they take over and manage. It’s typically a 20 percent stake in profits earned by the investments.
The lower tax rates apply to investments held more than a year by hedge fund managers, private equity managers, venture capitalists and certain real estate investors. Although hedge fund managers typically trade more frequently, some have found ways to get the benefit of lower rates.
Capital Gains
That portion of their compensation doesn’t correspond to personal investments by the fund managers, which is why Democrats contend that it should be treated like wages for services, not capital gains.
Republicans talk less often about carried interest, tucking the issue into broader debates about the tax code and the proper rates for capital gains.
The issue first received significant public attention in 2007, as Blackstone and Carlyle Group LP were planning initial public offerings.
Obama has made changing carried interest a staple of his budget proposals. His most recent budget plan would raise $17.7 billion over the next decade, according to the Treasury Department.
Republican Objections
Under Democratic control, the House of Representatives voted to raise taxes on carried interest. The provision—which was combined with other tax items—didn’t attract the 60 votes needed to overcome Republican procedural objections in the Senate, and Democrats didn’t push it through in the brief period when they controlled 60 seats.
The debate narrowed to technical questions, such as whether the founders of private equity firms would be eligible for capital gains treatment when they sold the firms themselves.
That, along with Camp’s draft, was a sign of consensus that carried interest would lose its tax benefits eventually, and industry officials stopped making “exaggerated statements” about potentially horrible effects of changing the tax code, said Victor Fleischer, a law professor at the University of San Diego. His academic paper on carried interest helped focus policy makers’ attention on the issue.
Conversation’ Changed
“The law has not changed, and I think the prospects of reform on the issue of carried interest are only somewhat promising,” Fleischer said. “On another level, the whole conversation has changed.”
Once Republicans took the House majority in the 2010 election, lawmakers’ focus shifted to a broad revamp of the tax code. In that context, Camp included some changes to carried interest in his draft.
The Obama administration has been timid in its attempts to use its regulatory authority to limit the tax benefits of carried interest, said Steve Rosenthal, senior fellow at the Tax Policy Center in Washington.
“They are not inclined to take any bold steps either at the IRS or Treasury,” he said. “That’s just not this administration.”
Rosenthal said the private equity industry has succeeded in preventing Congress from acting on carried interest.
“The private equity industry was very effective at tying the private equity debate into broader questions, questions of when there should be capital gains preferences and when should there not be,” he said. “They’ve tied up the Congress for six or seven years. It’s really phenomenal.”
Steve Judge, who runs the industry’s lobbying efforts in Washington, said the private equity industry needed to explain itself to each new crop of lawmakers.
Brand-New Issue’
“It was a brand-new issue for Congress,” he said. “We’ve spent seven years really doing a very intensive educational campaign on Capitol Hill, with the media, with policymakers, with influentials, that I think has paid off.”
Even with some changes in compensation structures for managers, carried interest remains important as a way to align managers’ interest with the companies they’re trying to sell or take public, Judge said.
“We are always vigilant about what could happen on the Hill at any given time,” he said. “Clearly, one-off kind of rifle-shot provisions make it into legislation. I don’t think that’s very likely to happen to us or to happen to carried interest.”
—With assistance from Angela Greiling Keane in Washington.
