Thoughout debates over reducing the nation’s deficit, President Obama has proposed the closure of certain tax loopholes as a way to raise new revenue. The carried interest loophole, which lets wealthy hedge fund managers pay a lower tax rate on certain income, has been chief among the loopholes Obama wants to close, and with the debate over federal spending accelerating yet again, Obama renewed his call to close the loophole in a pre-Super Bowl interview with CBS:
OBAMA: There is no doubt we need more revenue coupled with smart spending reductions in order to bring down our deficit. And we can do it in a gradual way so it doesn’t have a huge impact. And as I said, when you look at some of these deductions that certain folks are able to take advantage of, the average person can’t take advantage of them. The average person doesn’t have access to Cayman Island accounts, the average person doesn’t have access to carried interest income where they end up paying a much lower rate on billions of dollars that they’ve earned. And so we just want to make sure that the whole system is fair, that it’s transparent, and that we’re reducing our deficit in a way that doesn’t hamper growth, reduce the kinds of strategies that we need in order to make sure that we’re creating good jobs and a strong middle class.
The carried interest loophole is one that benefits a small number of hedge fund and private equity managers, who collect income via management fees and by taking a cut of their investors’ profits. The loophole allows the portion of income they make from investors’ profits to be treated as capital gains income, which is taxed at a lower rate than ordinary income. By reducing the amount they collect in management fees and instead taking the majority of their earnings from profits, the managers are able to substantially reduce the amount of taxes they pay on that income.
Proponents of the loophole argue that carried interest, like capital gains, should receive a preference because it is a return on investment income. But as the Center for American Progress’ Seth Hanlon and Gadi Dechter explained, carried interest is “derived from the labor and skill involved in managing other people’s investments,” and as such, it should be treated as ordinary income.
That results in a major loss of revenue for the United States. The Congressional Budget Office estimates that closing the carried interest loophole would generate $21 billion over the next decade.