Trump Promised to Kill Carried Interest. Lobbyists Kept it Alive.
Posted December 22, 2017 5:14 p.m. EST
WASHINGTON — President Donald Trump’s signature on the Republican tax bill marks his most important legislative achievement to date. It also represents the breaking of a signature promise that helped propel his populist presidential campaign.
This week, as senior White House officials touted passage of the tax overhaul in Congress, they also expressed one regret: failing to close the carried interest “loophole” that benefits wealthy hedge fund managers and private equity executives. Despite Trump’s vows to eliminate a tax rule that allows some rich business leaders to pay lower tax rates than their secretaries, the president in this case was no match for the powerful lobbyists protecting the status quo.
“I don’t know what happened,” said Larry Kudlow, the conservative economist who crafted Trump’s campaign tax plan. “I don’t know how that thing survived,” he said, adding “I’m sure the lobbying was intense.”
Carried interest is the percentage of an investment’s gains that a private equity partner or hedge fund manager takes as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is about 20 percent. Under existing law, that money is taxed at a capital-gains rate of 20 percent, which is about half the top individual income rate, which is currently 39.6 percent and will fall to 37 percent under the final tax bill.
Critics of the existing practice, which include both Democrats and Republicans and billionaire Warren Buffett, argue that this money is effectively income and should be taxed as such at the ordinary individual income tax rate.
Trump used to be one of those critics.
Two months after kicking off his campaign, Trump railed against hedge fund managers in an August 2015 interview for being “guys that shift paper around,” who were “getting away with murder” by not paying their fair share of taxes. “They make a fortune, they pay no tax,” he said. “They have to pay taxes.”
A year later, in a speech at the Detroit Economic Club, Trump was more explicit about what he planned to do about it if elected.
“We will eliminate the carried interest deduction, well known deduction, and other special interest loopholes that have been so good for Wall Street investors and for people like me but unfair to American workers,” Trump said, incorrectly referring to the special treatment of carried interest as a tax deduction.
So what happened?
Gary D. Cohn, the director of the White House’s National Economic Council, said Wednesday that the administration tried more than two dozen times to eliminate the carried interest loophole and that, as recently as this week, Trump asked why it was not gone.
Cohn, a former top Goldman Sachs executive, said opposition from lobbyists and lawmakers on Capitol Hill was intense and that the best that could be done was to extend the “holding period” for investments that qualify for the tax break to three years from one.
“The president strongly believes, and he ran on this, that carried interest is a loophole,” Cohn said at an event sponsored by Axios. He said the president continues to believe that venture capitalists and hedge fund managers are getting a preferred rate of return on someone else’s capital.
While the president managed to get much of what he wanted in the tax bill, including a lower corporate rate and a lower top individual rate, Cohn suggested that Trump had met his match when it came to those carrying water for carried interest.
“The reality of this town is that constituency has a very large presence in the House and the Senate and they have really strong relationships on both sides of the aisle,” he said.
Critics pounded on that explanation, saying that Trump could have done away with it had he publicly intervened. Unlike the other provisions Trump advocated for, eliminating the carried interest loophole would have actually raised revenue for the Treasury.
“Ending this specific Wall Street giveaway was a defining economic promise that Donald Trump made to the American people, claiming that it set him apart from other Republicans,” said Andrew Bates, a spokesman for the Democratic political action committee American Bridge. “This is the latest proof that Trump’s rhetoric on the campaign trail was nothing but empty.”
Lobbyists for private equity, venture capital and real estate groups, aware of Trump’s opposition to carried interest, mobilized their forces early this year to prevent the carried interest tax break from being eliminated. In particular, they sought to ensure that tax preferences for long-term investment were not scrapped as part of an effort to punish hedge fund managers, who typically turn over investments more quickly.
The groups appealed to lawmakers as engines of job creation, saying their industries were responsible for creating millions of jobs across the country. They pressured Republicans, particularly in the House, to fight to keep their taxes from going up. They also took their battle to Steven Mnuchin, the Treasury secretary and a former hedge fund manager, who has publicly sympathized with their arguments.
Pressed earlier this year in an interview with the Fox Business Network as to whether carried interest should be treated as ordinary income or if it deserved a special, lower rate, Mnuchin said that it was different from regular income but demurred as to how it should be taxed.
“Again, it’s a complicated issue,” Mnuchin said. “It’s not that much money,” he said, referring to how much the tax break costs the federal government. The Congressional Budget Office has estimated the tax break costs the federal government about $18 billion over a decade. To the industries that enjoy the tax break and the lawmakers who do their bidding, the stakes were clearly high.
A June letter from 22 members of Congress to Rep. Kevin Brady, R-Texas, the chairman of the Ways and Means Committee, and Rep. Richard D. Neal of Massachusetts, its top Democrat, argued that carried interest was not a loophole and that curbing it would be bad for the economy and harmful to business.
Throughout the year, financial contributions from the securities and investment industries flowed to Brady, House Speaker Paul Ryan, Sen. Orrin G. Hatch, R-Utah, the chairman of the finance committee, and Sen. Mitch McConnell, the majority leader.
During the last few months, lawmakers who were central to the process of rewriting the tax code would often dodge the question and say they did not know what was happening with carried interest when asked about it in the halls of the Capitol.
Ultimately, it was largely left alone.
“The private equity, venture capital, and real estate industries won on carried interest because they stressed the critical role that long-term investment plays in the U.S. economy, and they pushed all the right levers along the way,” said Ken Spain, a Washington-based consultant who has worked with the private equity industry on tax issues.
Mike Sommers, the head of the American Investment Council and top lobbyist on the carried interest issue, said this year was the most proactive his group has been on the issue since 2012 when Mitt Romney, a former private equity executive, ran for president and the industry came under assault. While Sommers was generally pleased with the outcome of the tax bill, he said it was still disappointing that the term “carried interest” is now being written in the tax code for the first time. This makes it more likely that future lawmakers will try to raise taxes on private equity funds. Also, while the three-year holding period will not affect many firms that hold onto assets longer, he said it could scuttle some deals that might have otherwise happened more quickly.
Sommers said that there was tension both within the White House and among Republicans in Congress throughout the year on how carried interest would be handled. He said that Mnuchin was often the mediator who pushed to protect private equity.
“What came out of this is what I would call the Mnuchin compromise,” Sommers said. “He wanted to make sure that we weren’t discouraging the kind of investment that we provide. Secretary Mnuchin certainly would be an all-star on this in terms of our perspective.”
Even with all of the investment industry’s lobbying muscle, Sommers said that the wild card was the person living in the White House, and that he could never be too sure how things would play out. Trump made a habit throughout the process of wading into the tax debate through Twitter, sending lawmakers scrambling.
“We of course were concerned about an errant tweet from President Trump on this or him doing something,” Sommers said.
In this case, the tweet never came.