The Democrats’ Inflation Reduction Act tightens a notorious tax loophole benefiting hedge fund managers and other wealthy investors. The nefarious tax loophole “Carried Interest” is one of the most infamous in American politics.
Will Sen. Kyrsten Sinema vote for it or against it when it comes up for a vote this week in the US Senate? Nobody knows what the Diva will do. She has supported a minimum tax on large corporations (which is part of the Inflation Reduction Act), but she has also objected to increasing corporate taxes.
The picture becomes clearer when you see that the right-wing Koch organization just heaped praise on her. It becomes even clearer when you see that Big Pharma and investment banks have made hefty donations to her.
Paid less in taxes than a secretary
The “Carried Interest” loophole is what billionaire investor Warren Buffett refers to when he says how he pays a lower tax rate than his secretary. Simply, Carried Interest is a share of the profits of a private equity or hedge fund that is paid to fund managers. Traditionally, Carried Interest totals 20% to 25% of profits. This percentage is huge compared to management fees.
But under the loophole, Carried Interest in private equity is classified as capital gains and is taxed at the capital gain tax rate. It is a favorable rate compared to the ordinary tax rate. The management fees are taxed up to 37% because they are viewed as ordinary income in the eyes of the Internal Revenue Service.
Carried Interest, however, can be taxed at capital gains rates of much less – from 15% or 20%. However, Carried Interests are not capital gains but are actually income from labor and, therefore, should be taxed at the higher ordinary rates on income.
To sum up:
- Carried Interest is a share of private equity or fund profits that serve as fund managers’ compensation.
- Because the loophole considers Carried Interest to be a return on investment, it is taxed at the lower capital gains rate and not higher income rates.
- Advocates of Carried Interest argue that it supercharges fund managers to make titanic profits.
Both President Obama and Trump spoke about getting rid of the Carried Interest loophole. Trump even made an issue of this special tax benefit during his presidential campaign. He labeled some hedge fund managers as “paper pushers” who are “getting away with murder.” President Obama said, “I will tell you that keeping this tax loophole, which leads to folks paying lower rates than their secretaries, is not helping the American economy.”
What is on the Diva’s mind?
The “Taxpayers Protection Alliance” ran a full-page ad in the July 30 Arizona Daily Star, thanking Sinema for rejecting “President Bidens’ tax on small businesses” and “saying Arizona taxpayers and consumers appreciate your commitment to a strong economy. It turns out the Taxpayers Protective Alliance is an advocacy front group for the Koch political network.
A 300-page report on the 2007-08 housing bubble collapse makes clear that Carried Interest and sub-prime mortgages go hand in hand. For example, John Paulson, a hedge fund manager, managed to make more than $3.7 billion in 2007 and $5 billion in 2010 — all from shorting the sub-prime mortgage market during the housing price bubble.
But it turned out he wasn’t the financial genius that people thought. Two brokerage firms, Bear Stearns and Goldman Sachs, were feeding him information on which mortgage-backed securities were rated junk. Thus, it was easy for Paulson to short sell these securities, knowing that when the time came to pay up, the stocks would be almost worthless. Paulson ended up paying only 30% in taxes on the first billion and only 15% on the rest.
Fully 99.999% of American taxpayers are not eligible to take advantage of the Carried Interest loophole because they are not hedge fund managers or sitting US senators like Sinema. So, what could be gained by having millionaires and billionaires paying less in taxes?
But again, when it comes to the Diva, nothing is normal.