The Camp Plan and 'Carried Interest'

The Camp Plan and 'Carried Interest'

There's a new tax plan on the block. Our update today features an oped by its sponsor, Rep. Dave Camp.

Like every tax plan, Camp's gives us a lot to digest, but one issue that's getting some attention is its treatment of "carried interest." Specifically, Camp claims he will "clean up provisions like 'carried interest' that allow certain private-equity firms to get the investment-income tax rate on what anyone else would call normal wage income." Here's what's going on with that.

A syndicated Bloomberg piece nicely summarizes what carried interest is:

Under current law, carried interest, or the profits share received by private equity managers, gets treated as capital gains, with a top basic rate of 20 percent as opposed to the ordinary income rate of 39.6 percent.

But it's worth unpacking this a little bit. For most of us, there's a distinction between the money we earn by working and the money we earn in the form of capital gains (stocks, etc.). Specifically, the capital gains are taxed at a special lower rate. The basic idea is that when someone has money, it's good to encourage them to put it toward investment rather than consumption (which isn't taxed at all at the federal level).

However, instead of receiving a salary for the work they do, private-equity managers are paid a share of the profits on the investments they manage. This income is labeled "carried interest" and taxed at the capital-gains rate. In other words, a lot of very rich people are paying relatively low rates on income that they earned through labor.

Some have made the case for the lower capital-gains rate more broadly by pointing out that corporate profits are taxed before they are distributed to shareholders, making the capital-gains tax a form of double taxation. (By contrast, when a corporation pays a salary, it can deduct the amount from its taxable income.) But this does not apply here; private-equity firms are organized as "pass-through" entities rather than corporations, and thus avoid entity-level taxes. Even carried interest's supporters concede that it reduces the amount of taxes paid relative to a situation in which managers are paid for their services with a salary (or a bonus based on fund performance).

There's a lot more to this, of course. Those who want to go deeper into the weeds can see criticisms of carried interest here and here, and defenses here and here.

Robert VerBruggen is editor of RealClearPolicy. Twitter: @RAVerBruggen

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