Fix Predatory Capitalism: Close the Carried Interest Loophole

People who want to reform predatory capitalism should learn two words: carried interest.

Carried interest is much more than a nerdy accounting term. It is the reason why three of the most lecherous forms of modern financial businesses—private equity firms, hedge funds, and real estate developers—have skirted paying their full amount of federal taxes, destroyed jobs, and then used their ability to make huge profits to buy their way into Congress.

In the months before the November 2020 presidential election, these firms that have profited so much due to this federal tax loophole, are now making large contributions o the Trump presidential campaign in order to continue to buy influence through Trump and Congress.

As we know, elected officials of both parties are all too willing to take money from these industries. The enticement is too great to resist.

That’s why the latest report from Bloomberg news finds that the private equity industry, one of Trump’s largest financial contributors, is now bailing him out through the contributions of one of private equities top executives, Stephen Schwartzman, co-founder and CEO of the Blackstone Group.

The Bloomberg article found that Schwartzman, “the private equity mogul single-handedly accounts for the vast bulk of the reported contributions toward Trump’s re-election effort over the past 18 months from people associated with the 31 banks and investment firms that dominate the U.S. financial industry.”  His contributions alone amounted to $3.7 million of the $4.8 million from this group of private equity firms and banks.

So, why does private equity contribute so much to Trump?  To protect the carried interest loophole. The cover story is that these firms may like his political policies and philosophy, but these wealthy contributors would have to engage some fiction writers to articulate those policies.

What we do know is that the carried interest loophole is why these firms make so much money.

Carried Interest Defined

Carried interest is the shares of profits PE funds receive when they sell companies. These sales are taxed at 15% or 20%, the standard capital gains rate. This is much lower than the top 37% regular income tax rate. As a result, Mitt Romney, whose firm Bain Capital, that makes huge profits from this tax loophole.

The gains of PE firms are taxed at a capital gains tax rate of 15%, but the money earned on behalf of investors also is treated as a carried interest at a tax rate of 15%.  People who want to close this loophole contend these PE profits should be treated as regular income and not be subject to special tax treatment.

Trying to Close the Loophole

Numerous progressives have tried to close this loophole, especially Sen. Bernie Sanders and Sen. Elizabeth Warren.  In the 2012 presidential campaign, even candidate Barack Obama roundly criticized Republican candidate Mitt Romney for his profits from the carried interest loophole. He made a powerful argument that should be repeated today.

“Exactly how much Mr. Romney benefited from the carried-interest loophole could not be determined, since he refused to release his tax returns before 2010. But as a former Bain Capital partner, he received substantial carried interest — 31 percent of his 2010 and 2011 income, The Boston Globe reported,” according to the New York Times.

Three of the most predatory and lucrative investment categories that victimize millions of Americans and evade their respective tax responsibilities all have a common denominator: the esoteric tax loophole known as carried interest. Now, it is time to close it.

This tax loophole is the most protected in the collected tomes of tax regulations. It is the pillar of profitability and preferential tax treatment for three investment categories: private equity, hedge funds, and real estate development.

Carried Interest Defined

Carried interest is the shares of profits PE funds receive when they sell companies. These sales are taxed at 15% or 20%, the standard capital gains rate. This is much lower than the top 37% regular income tax rate. As a result, Mitt Romney, whose firm Bain Capital, that makes huge profits from this tax loophole.

The gains of PE firms are taxed at a capital gains tax rate of 15%, but the money earned on behalf of investors also is treated as a carried interest at a tax rate of 15%.  People who want to close this loophole contend these PE profits should be treated as regular income and not be subject to special tax treatment.

If Democrats want to restrain three of the most predatory financial industries—private equity, hedge funds, and real estate development—they must close the carried interest loophole.

Who Opposes Closing the Carried Interest Tax Loophole?

Money talks and money controls the politicians who want to prevent closing this critical tax loophole. This includes the Republicans and some corporate Democrats who readily take Wall Street lobbying money, such as Chuck Schumer. In the 2012 presidential campaign, candidate Barack Obama roundly criticized Republican candidate Mitt Romney for his profits from the carried interest loophole. He made a powerful argument that should be repeated today.

“Exactly how much Mr. Romney benefited from the carried-interest loophole could not be determined, since he refused to release his tax returns before 2010. But as a former Bain Capital partner, he received substantial carried interest — 31 percent of his 2010 and 2011 income, The Boston Globe reported,” according to the New York Times.

Sen. Elizabeth Warren introduced legislation in 2019 to reform private equity. The bill had a solid core of progressive and very liberal Democrats who supported the bill. No Republicans supported the bill and worked hard to prevent it from advancing it in Congress. Now, there is a possibility that Elizabeth Warren could be appointed Treasury Secretary in the Biden administration if Biden wants to attract more progressive voters.

Warren’s bill, the Stop Wall Street Looting Act, had three key provisions focused on closing the carried interest loophole.

• It would convert capital gains attributable to carried interest to a higher ordinary income rate;
• It would impose more stringent limitations on interest deductions for leveraged investment funds;
• And, it would effectively impose a 100% surtax on fees paid from target companies to investment advisors.

Private Equity Expands it Tentacles into 401ks

But efforts to close this sacred tax loophole is no match for the financial services industry lobbyists. To exercise its powerful political muscle, the private equity industry has now pushed its way into the $9 trillion 401(k) industry.

This has happened as longstanding worker-protection regulations have prevented 401(k) plans from investing in high-risk, high-fee private equity firms. The recent Department of Labor regulatory letter now permits corporations that sponsor 401(k)s to offer private equity funds inside of 401(k) plans to unsophisticated investors.

How much money can private equity funds expect to snag from this unsophisticated market?  “If just 5% of the money in these retirement funds were available to private equity, it would be a windfall of $435 billion — real money even to private equity millionaires and billionaires,” wrote Eileen Appelbaum of the Center for Economic and Policy Research.

From the beginning, Trump’s White House has been operating as a de facto subsidiary of the private equity industry: His reelection campaign is being bankrolled by private equity donors Wilbur Ross, Trump’s Commerce Secretary, is a major force in private equity.  Trump SEC chairman was a Wall Street lawyer at a firm that represents private equity clients. Trump’s first National Economic Council was the president of a private equity giant. Trump’s top outside adviser is Steven Schwarzman, the CEO of the world’s largest private equity firm, Blackstone. Blackstone is a major donor to the Republican Party and his firm was named as the main broker for purchasing stocks and EFTs for the Federal Reserve’s bailout program.

What’s Biden Going to Do?

Voters in the upcoming presidential election should ask Biden to move carried interest to a campaign promise.

Biden is a corporate Democrat and will receive millions from the Wall Street lobby to oppose any changes to this loophole.

But if he wants to attract younger voters, Biden should educate voters about carried interest.  No sane politician will publicly defend this the private equity business and the carried interest loophole, but they will lie about trying to close it.

Biden and some corporate Democrats in his circle will love to see this issue die, so it is the responsibility of average Americans to learn about carried interest. Make the billionaires pay their share of federal taxes. In the process, they will also curtail or eliminate some of the most predatory forms of modern finance.