From early in the 2016 presidential campaign, Donald Trump swore he’d do away with the so-called carried-interest loophole, the notorious tax break that allows highly compensated private-equity managers, real estate investors and venture capitalists to be taxed at a much lower rate than other professionals.
“They’re paying nothing, and it’s ridiculous,” Trump said in August 2016. “These are guys that shift paper around and they get lucky.” They were, he concluded, “getting away with murder.”
As recently as late September, his chief economic adviser, ex-Goldman Sachs executive Gary Cohn, insisted that the administration was set on closing what’s also referred to as the “hedge-fund loophole,” though hedge funds profit from it less than private-equity firms. “The president remains committed to ending the carried interest deduction,” Cohn told CNBC. “As we continue to evolve on the framework, the president has made it clear to the tax writers and Congress. Carried interest is one of those loopholes that we talk about when we talk about getting rid of loopholes that affect wealthy Americans.”
Yet the sweeping tax legislation released by House Republicans leaves the treatment of carried interest untouched.
The preservation of the loophole is only the latest and starkest example of how a policy that is increasingly attacked as unfair and unjustified by people on both sides of the aisle has managed to survive through the influence of its well-placed beneficiaries.
When it comes to the new tax bill, that influence surely included Stephen Schwarzman, chief executive of the Blackstone Group, one of the largest private-equity firms in the country. In 2010, when Congress, then controlled by Democrats, came close to closing the loophole, Schwarzman compared the proposal to the Nazi invasion of Poland. (He later apologized.) Schwarzman alone is estimated to have saved close to $100 million per year as a result of the treatment of carried interest, which makes up the vast bulk of his roughly $700 million annual income in recent years.
A major longtime donor to Republican candidates, Schwarzman did not give directly to Trump during the 2016 campaign, when Wall Street giving was in fact heavily tilted toward Hillary Clinton, even though she vowed to go even further in closing the loophole than Trump did. But Schwarzman quickly emerged earlier this year as a leading and highly influential advisor to Trump.
The loophole dates to almost a century ago, in the tax treatment of profits from oil-drilling partnerships, but its cost to the Treasury has exploded only in the past couple decades with the boom in the private equity industry. Those who manage the investments in private-equity funds are typically compensated in two different ways: with a 2 percent fee on the funds under management, and with a 20 percent cut of the gains they produce for investors — their “carried interest.” That 20 percent cut is taxed under the capital gains rate, which currently amounts to 23.8 percent for the wealthy, instead of at the top rate for ordinary income, 39.6 percent, even though it is, essentially, part of the compensation that these investment managers are receiving for their labor, which is managing other people’s money.
The loophole has also been very valuable to partners in large-scale real estate investment — such as Trump himself. Estimates of the loophole’s total cost to the Treasury range from $1 billion per year to more than $10 billion.
Defenders of the loophole — who reject even the term “loophole” — have long argued that applying the lower capital gains rate to carried interest justly rewards the risk-taking involved in private-equity partnerships. But in recent years, even some people within the industry have grown more muted in their defense, as the loophole has become increasingly implicated in soaring incomes at the very top of the ladder.
For instance, David Rubenstein, the co-founder of another very large private equity firm, the Carlyle Group, in recent years has shifted from explicitly defending the loophole to rebuffing legislative attempts to close it by arguing that it would be better addressed as part of comprehensive tax reform. “I don’t think anything will get done until comprehensive tax reform is discussed and everything’s looked at,” Rubenstein told this reporter in October 2015, at a New York event where he was being honored for his philanthropy.
That was an effective way to defer focused efforts to eliminate the tax break, without appearing to defend it outright. And now a comprehensive tax reform bill is finally on the table. And closing the loophole is not in it.