Democratic tax reformers have long sought to close the carried interest tax loophole, but Arizona Senator Kyrsten Sinema, who has received significant funding from wealthy financiers, proved to be the main obstacle.

The tax bill wouldn’t have passed without the removal of the provision. Changes to carried interest would only affect the tax rates private equity managers pay. Investors would be unaffected. Nonetheless, even those who support closing the tax loophole acknowledge that the projected revenue loss would be relatively minimal.

Senate Majority Leader Chuck Schumer claimed that Democrats had “no choice” but to remove that provision from the Inflation Reduction Act in order to secure Sinema’s vote and pass the legislation.

Instead, the plan imposes a 1% tax on all company share buybacks and a minimum 15% corporation tax rate on businesses with more than $1 billion in annual revenue. With Vice President Kamala Harris’ tie-breaking vote on Sunday, August 7, 2022, the large spending and tax package narrowly passed the equally split Senate 51–50.

What Is Carried Interest?

Carried Interest is the percentage of an investment’s gains that a private equity or hedge fund manager takes as compensation.

What Is Carried Interest Tax Loophole?

While there’s nothing wrong with incentives and compensation, the issue that bothers taxpayers is actually how the carried interest is taxed. Fund managers who receive carried interest are able to get a tax break on their income and end up paying the same amount as an average American taxpayer.

Hedge fund managers have their salaries taxed at a lower rate than ordinary income. Carried interest, on the other hand, is taxed at the capital gains rate, which is normally 20% for individuals with high incomes rather than the standard individual income tax rate of 37% for the highest bracket of earners.

History of the Carried Interest Tax Loophole

The idea of closing the proposal of the carried interest tax loophole has been around for a long time. It first surfaced in national headlines in 2007 after a law professor wrote an article about the loophole, which then successfully launched a debate on Capitol Hill over whether to close it or not.

Attempts to close the loophole were made repeatedly over the years, with notable discussions during the 2012 elections and promises from both Hillary Clinton and Donald Trump in 2016, yet no legislative proposal to close the loophole has ever succeeded.

Why Hasn’t The Carried Interest Tax Loophole Ever Been Closed?

According to the Congressional Budget Office (CBO), if the carried interest loophole were closed, it would produce about $14 billion over the course of 10 years, which was intended to help pay for $433 billion in spending on climate and health initiatives.

The significant campaign contributions from private equity firms and their lobbyists, totaling close to $600 million over the past decade, have played a role in maintaining the status quo, despite attempts by multiple U.S. Presidents and legislators to abolish the loophole.

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