WASHINGTON – Once again, interest bore the day.
The Senate Democrats’ last-minute removal of a provision in the climate and tax law that would narrow what is often referred to as the “carried interest loophole” represents the latest victory for the private equity and hedge fund sectors. For years, those companies have successfully lobbied to destroy bills aimed at ending or mitigating a quirk in the tax code that could allow executives to pay lower tax rates than many of their salaried employees.
In recent weeks, it looked like the benefit could be scaled back, but a last-minute intervention by Arizona Democrat Senator Kyrsten Sinema put an end to what would have been a $14 billion tax hike targeting private equity. .
The inability of lawmakers to address a tax break that Democrats and some Republicans have called unfair underscores the influence of financial industry lobbyists and how difficult it can be to change the tax code.
The deal that Democratic leaders made with Ms. Sinema not only abolished the carry-interest provision, but also included a 1 percent excise tax on share buybacks and changes to a minimum 15 percent corporate tax that favored manufacturers.
On Friday, the private equity and hedge fund sectors applauded the development, describing it as a win for small businesses.
“The private equity sector directly employs more than 11 million Americans, fuels thousands of small businesses, and delivers the highest returns for pensions,” said Drew Maloney, the chief executive of the American Investment Council, an advocacy group. “We encourage Congress to continue to support private capital investment in every state in our country.”
Bryan Corbett, the chief executive of the Managed Funds Association, said: “We are pleased to see a twofold recognition of the role private capital plays in growing companies and the economy.”
Carried interest is the percentage of an investment’s profit that a private equity partner or hedge fund manager takes as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is about 20 percent.
Under existing law, that money is taxed at a 20 percent capital gains rate for top earners. That’s about half the rate of the highest individual income tax bracket, which is 37 percent. A tax bill passed by Republicans in 2017 left carry-rate treatment largely intact, after an intense lobbying campaign, but narrowed the exemption by requiring executives to hold on to their investments for at least three years to seek preferential tax treatment. to enjoy.
An agreement reached last week by Senator Joe Manchin III, Democrat of West Virginia, and Senator Chuck Schumer of Majority Leader of New York, would have extended that three-year period to five years, while the way the period is calculated in the hope has changed. of reducing taxpayers’ ability to take advantage of the lower 20 percent tax rate.
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But Ms. Sinema, who has received political donations from wealthy financiers who usually donate to Republicans and who was cool with the idea of targeting last year, expressed interest, objected.
Over the past five years, the senator has received $2.2 million in campaign contributions from investment industry executives and political action committees, according to OpenSecrets, a nonprofit that tracks money in politics. The industry was second to retired individuals in giving to Ms. Sinema and just ahead of the legal profession, earning her $1.8 million.
For years, carry interest has been a piñata of fiscal policy that never cracks open.
During the 2016 presidential campaign, Donald J. Trump said, “We will eliminate the carry-interest deduction, known deduction, and other special interest loopholes that were so good for Wall Street investors and people like me, but unfair to American workers.” .”
When President Biden became president in 2020, his campaign said he would “eliminate special tax breaks that reward special interests and close the loophole in capital gains for multimillionaires.” To do that, he said, he would tax long-term capital gains at the normal income tax rate, essentially wiping out the special treatment of carry interest.
A similar proposal appeared in Mr Biden’s budget last spring, but when Democrats tried unsuccessfully to pass their Build Back Better legislation over the summer and fall, interest disappeared.
Jared Bernstein, a member of the White House’s Council of Economic Advisers, deplored the outcome. “This is a loophole that absolutely must be closed,” Mr. Bernstein told CNBC last September. “If you go up to Capitol Hill and start negotiating taxes, there are more tax lobbyists in this city than there are members of Congress.”
Ms. Sinema has long been a defender of the private equity industry, going back to her time in the House. In recent weeks, representatives from small business, venture capital and the renewable energy industry have provided Ms. Sinema and her associates with information about their presence in and importance to Arizona, according to a lobbyist familiar with the effort.
“Senator Sinema makes every decision based on one criterion: what’s best for Arizona,” said her spokeswoman Hannah Hurley.
The American Investment Council said venture capital and private equity firms invested $67 billion in Arizona between 2016 and 2020, and companies backed by private equity employ nearly 230,000 workers in the state. Several prominent private equity firms, such as Blackstone, KKR and Warburg Pincus, have companies in the state.
Executives from some of those companies have made campaign contributions to Ms. Sinema, including George Roberts, Henry Kravis and Joseph Bae at KKR and Sean Klimczak and Eli Nagler at Blackstone.
Even within the financial sector, opinions differ on the treatment of the carry-interest tax. In posts on Twitter in late July, Bill Ackman, the founder of Pershing Square Capital Management, a New York hedge fund, said that while “favorable tax treatment” was essential for new company founders, people who manage funds that own many companies do not. are entitled to the same benefit.
“The loophole on the carry rate is a blot on the tax code,” he wrote in one message. “It doesn’t help small businesses, pension funds, other hedge fund investors or private equity investors and everyone in the industry knows it. It’s a shame and it should stop now.”
The whole time, some analysts were skeptical that lawmakers would actually change the carry-interest tax treatment in the final bill. While it has become a high-profile target, the change Democrats sought would have brought in little tax revenue compared to other provisions in the legislation known as the Inflation Reduction Act.
“Carried interest has become the MacGuffin of the IRA saga,” said James Lucier, an analyst at Capital Alpha Partners, a Washington policy research firm, describing it as a literary tool authors use only to make plots more interesting. “The MacGuffin diverted attention from the really important things in the story to ultimately make the surprising conclusion even more surprising.”
On Friday, some progressive policy experts dismissed the removal of the carry rate provision, which they viewed as only a modest improvement over the current law.
“The proposal that was in the bill until last night made a technical adjustment in the holding period for assets eligible for carry-interest treatment,” said Jean Ross, a senior fellow at the Center for American Progress, a liberal research group in Washington. “A better approach would address the issue directly and say that fees for services that manage an investment fund should be taxed as work and subject to normal tax rates.”
Ms. Ross added that she welcomed the addition of the stock buyback tax, which some Democrats and their allies have long supported, arguing that companies are overspending to buy back their own shares, instead of investing in research and development or giving employees pay rises.
Ms Sinema herself said little about the legislation or about why she considers it so important to maintain the tax deduction.
“We have agreed to remove the provision for tax-deferred taxes, protect advanced manufacturing and boost our clean energy economy in Senate budget reconciliation legislation,” she said in a statement on Thursday.
Emily Cochrane reporting contributed.
