President Barack Obama has proposed to treat carried interest as regular income in his proposed 2013 budget, a move that could reduce the US deficit by $13 billion over 10 years.
Under the current tax regime, carry is taxed at the 15 percent capital gains rate. If the proposal were adopted, income generated from carried interest would be taxed at the same levels as regular income – or as much as 35 percent at the highest income bracket.
“The President pro¬poses to eliminate the loophole for managers in investment services partnerships and to tax car¬ried interest at ordinary income rates,” according to the proposal.
Obama made a similar proposal in September as part of his effort to pass a comprehensive jobs bill, claiming at the time that raising the carried interest rate would generate $18 billion in revenues over the next decade. The President had also proposed an increase as part of his 2012 budget proposal.
Although this is not the first time the President has proposed changing carry’s designation as capital gains, the most recent proposal is timely as carried interest has emerged as an issue in the 2012 election campaign.
Obama’s likely opponent, former Massachusetts governor and Bain Capital founder Mitt Romney, has accumulated a sizable fortune through carried interest generated by Bain investments.
General partners should recognise that tax treatment of their income has become indefensible.
Private equity and capital gains rates were thrust into the spotlight when Romney, who is estimated to be worth around $250 million, told a crowd of voters in South Carolina that his effective tax rate is around 15 percent. According to reports, the majority of Romney’s income comes from a share of profits and returns from Bain Capital, as well as other investment income. Since then, Romney and the private equity industry have been attacked by both Democrats and Republicans and the media for allegedly profiting off of stripping companies of jobs and assets.
The Private Equity Growth Capital Council has already issued a statement against President Obama’s 2013 budget proposal: “Raising taxes on private equity investments would discourage the risk-taking required to start, grow, and save companies. Proposals to change the carried interest tax rate on private equity, real estate and venture capital, have been defeated on a bipartisan basis a number of times over the last five years and even with the highly-charged election year rhetoric it is uncertain that such a proposal will gain traction this Congress.”
However, as the issue has become more prominent, momentum may be shifting against the private equity industry’s stance. On Monday, California Public Employees’ Retirement System chief investment officer Joseph Dear criticised private equity’s current tax treatment as “indefensible” during a meeting of the $234 billion retirement system’s investment committee, according to a Fortune report.
“The risk premium that can be earned from investing in private equity is a really important source of the returns we need to make sure we can meet our earnings targets. This is not theoretical … But we are not here as a blind defender of private equity. I think private equity is neither as good as the cheer-leading crowd would have you believe or as bad as its detractors — on and off the political field – claim,” he said. “General partners should recognise that tax treatment of their income has become indefensible.”