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Democrats aim to partially tighten the carried interest loophole

ASMA KHALID, HOST:

You know that big, sprawling Senate compromise about health care and climate change that Democrats Joe Manchin and Chuck Schumer reached last week? Well, there is a lot in it, including this one particularly controversial nugget. It is what is known as the carried interest loophole. It's been a target of every president going back to George W. Bush. It lets wealthy hedge fund managers pay less in taxes. And the Democrats' Senate bill attempts to partially close that loophole. To take a deeper look at what exactly it is and why it's drawn so much political attention over the years, we've called up David Wessel. He's director of the Hutchins Center at the Brookings Institution. Welcome back to the program, David.

DAVID WESSEL: Good morning, Asma.

KHALID: So, David, let's begin with a definition. Help us understand what exactly carried interest is and who really benefits from this loophole.

WESSEL: Sure. Partners in private equity firms and hedge funds who generally manage other people's money get a share of the profits from any deal they do, often about a 20% share, even if they have invested any of their own money in it. Today, they pay taxes on that income at the capital gains rate, 23.8%. Under the tax code, this isn't considered part of their compensation. If it were, they'd be taxed at the ordinary income tax rate of up to 37%. And these folks make a lot of money. The Wall Street Journal says the 28 top executives of five big private equity firms shared $760 million in carried interest. That's more than $25 million each.

KHALID: Oh, wow.

WESSEL: So this loophole saves a few people a lot of money on their taxes.

KHALID: So, you know, over the weekend, Senator Manchin appeared on a number of Sunday shows. He was on Fox News Sunday defending this deal. And I was struck by the language he used. You know, he talked about loopholes.

(SOUNDBITE OF FOX NEWS BROADCAST)

JOE MANCHIN: We did not raise taxes. We've closed loopholes.

KHALID: So, David, this raises the question to me, I mean, does this massive bill, the Inflation Reduction Act, really do what Senator Manchin says that it will do?

WESSEL: Well, for those people who are affected, it's a tax increase. It raises about $14 billion over 10 years. That's a lot of money, although a small slice of all the money in this bill. It wouldn't completely close the loophole, but it would substantially restrict it. Partners would have to hold their investment for five years up from the current three to get the lower tax rate. And it would make all sorts of technical changes, all of which would get more money out of them for the Treasury.

KHALID: So, you know, in years past, we've seen both Republican and Democratic presidents try to close this loophole. Congress, Democrats included, I should point out, have resisted this effort. So help us understand why there has not been a consensus in Congress to do something about this.

WESSEL: Well, there are a lot of private equity and hedge fund partners who are big campaign contributors, including to Democrats, and they care about this a lot. And all the other constituents of Congress don't even know what it is. So despite the Democrats' tax the rich rhetoric, this provision always seems to fall out of any proposal before it's passed by Congress. And in fact, we still don't know if this one is going to survive. Senator Kyrsten Sinema, the Arizona Democrat who has not been happy about closing the carried interest loophole, hasn't said yet whether she'll support it. And since the bill requires all 50 Democrats to go along, it's - it could yet survive. It's worth noting that in 2017, it was the Republicans who succumbed to industry pressure and made very minor changes to carried interest despite President Trump's attacks on it.

KHALID: And, David, very briefly, what is the argument for leaving the loophole alone?

WESSEL: Basically, the industry says this tax increase will limit their ability to punish - to invest in small businesses and hurt the economy.

KHALID: David Wessel of the Brookings Institution, thank you as always.

WESSEL: You're welcome. Transcript provided by NPR, Copyright NPR.