by Oscar Valdés Viera, Senior Policy Analyst, Private Equity & Capital Markets
The carried interest tax loophole has probably been shielding far more Wall Street profits from taxes than had long been officially estimated. The private equity industry reaps as much as $10 billion a year in tax giveaways through the carried interest loophole.
New research from The Budget Lab at Yale finds that closing the loophole could raise tens of billions of dollars more than prior estimates suggested. The authors estimate that Senator Wyden’s recently introduced carried interest reform proposal would raise $87.7 billion over ten years—almost 40 percent more than the Congressional estimate of $63.1 billion. A broader proposal to tax carried interest as ordinary income could raise about $100 billion over a decade.
Tens of billions more reasons to finally close this loophole
The carried interest tax loophole allows private equity, venture capital, and other investment fund managers to pay lower capital gains tax rates—instead of ordinary income rates—on a major part of their monetary compensation. Teachers, nurses, and firefighters pay ordinary income tax rates on their wages. But billionaire fund managers get a special discount on the compensation they earned for the job of managing other rich people’s money.
The Budget Lab analysis explains that past estimates may have understated the scale of the giveaway because the tax code does not require partnerships (a frequently used business arrangement) to separately identify carried interest on tax forms, so revenue estimators have historically had to infer its size indirectly. However, recent academic detailed analysis of IRS Schedule K-1 and partnership filing data provides a more robust estimate of the income flowing to fund managers as profit allocations not backed by their own capital contributions. This new, more accurate methodology found that the private equity industry shielded substantially more profits through the carried interest loophole, now estimated to have increased from roughly $35 billion in 2011 to $89 billion in 2020.
In other words, official estimates may have significantly understated how much compensation the loophole has allowed to escape ordinary income tax rates over the years.
The carried interest loophole is a giveaway to the ultra-rich
That matters for tax fairness and also for the corporate behavior the tax code is subsidizing and incentivizing. Carried interest taxation is not a reward for patient, productive investment like its defenders claim. The loophole rewards a predatory business model that lets fund managers reap enormous tax-advantaged profits while putting relatively little of their own capital at risk. In private equity, that skewed incentive structure encourages short term asset plundering, excessive leverage, and extractive strategies that leave workers, patients, tenants, and communities paying the price when deals go wrong.
The theoretical argument for a lower capital gains rate is that it rewards people who put their own money at risk in investments for the long term. But carried interest is really compensation for services, dressed up as investment income. And taxing it as capital gains is a massive giveaway for some of the richest people in the country—one that may cost the public nearly $100 billion over the next decade if lawmakers continue to protect it.