The war over a tax break for hedge funds and money managers

The so-called carried interest loophole is a tax break used by hedge funds and other investment groups that lets wealthy money managers pay a relatively low investment tax rate. Economics correspondent Paul Solman takes a close look at the controversial tax break.

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  • GWEN IFILL:

    Now: a tax break that is coming under fire, one used by hedge funds and money managers, controversial because of the way profits are taxed at a much lower rate.

    Our economics correspondent, Paul Solman, explores what it's all about, part of our weekly series Making Sense, which airs every Thursday on the NewsHour.

  • PROTESTERS:

    Hey, hedge fund billionaires!

  • PROTESTERS:

    Pay your fair share!

    Hey, hedge fund billionaires, pay your fair share!

  • PAUL SOLMAN:

    The Hedge Clippers, an activist group targeting hedge fund billionaires and especially their tax breaks. In the past few months, the Clippers have been taking their tools to their targets' backyards, like their March field trip to Greenwich, Connecticut.

  • PROTESTERS:

    Hedge funds, pay your taxes! Billionaires, pay your taxes!

  • PAUL SOLMAN:

    Their July jaunt to the Hamptons, summertime playground of the 0.1 percent.

  • PROTESTERS:

    We can see your greedy side.

  • PAUL SOLMAN:

    And, earlier this month, to the Midtown Manhattan headquarters of Bloomberg, where a conference was taking place to — quote — "celebrate the leaders and innovators who shape economies."

  • PROTESTERS:

    Pay your fair share.

  • PAUL SOLMAN:

    But not in a good way, say the Clippers.

  • PROTESTER:

    These are the same hedge funds…

  • PROTESTERS:

    These are the same hedge funds…

  • PROTESTER:

    … that foreclose on our homes.

  • PROTESTERS:

    … that foreclose on our homes.

  • PAUL SOLMAN:

    And what's especially galling, says protest leader Charles Khan, is that hedge fund managers and private equity firms get a special tax break to do so.

  • CHARLES KHAN, Hedge Clippers:

    They're paying less taxes than kindergarten teachers, firefighters, truck drivers, secretaries.

  • PAUL SOLMAN:

    Because of what's known as the carried interest loophole.

  • MORRIS PEARL, Chairman, The Patriotic Millionaires:

    The term originated from ship captains getting a 20 percent commission on the things they carried, so it's called the carried interest.

  • PAUL SOLMAN:

    Morris Pearl's no Hedge Clipper, but he's a kindred soul, having retired early from the Wall Street behemoth BlackRock to run the Patriotic Millionaires, a group that's pushing to end tax breaks for those who have amassed money, or just inherited it.

  • MORRIS PEARL:

    I don't see why I should be paying tax at a lower rate than other people because I happen to have the good fortune of being — frankly, being wealthy enough to live off my investments, instead of having to work.

  • PAUL SOLMAN:

    That's because the top income tax rate is almost 40 percent for all earned household income above about $450,000. But the top tax rate on long-term capital gains, the profits from sales of investments like stocks or real estate owned for more than a year, is only 20 percent.

    And here's the rub: The people who manage those investments also get the capital gains tax rate, because of their supposed carried interest.

  • MORRIS PEARL:

    The carried interest loophole is the most egregious example of unfairness that I have seen.

  • PAUL SOLMAN:

    Egregious, Pearl thinks because, despite the argument made by this private equity video, money managers aren't risking anything.

    But, because they form so-called partnerships with their investors, they get to cut their tax bill in half by reporting their share of profits as a carried interest capital gain.

    The industry's rationale? The managers are investing something: their effort.

  • NARRATOR:

    The private equity firm contributes sweat equity by forming the investment fund, identifying the companies to buy and applying expertise to improve the purchased companies over time. When the private equity firm sells a company, its limited partners receive their initial investment, plus 80 percent of the profits thereafter.

    The remaining 20 percent of the profits goes to the private equity firm. This is called a carried interest.

  • PAUL SOLMAN:

    But, according to Patriotic Millionaire Whitney Tilson, money managers like him already take whopping fees, and the share of profits is really no different.

  • WHITNEY TILSON, Kase Capital Management:

    I'm just taking a 20 percent bonus, just like the shoe salesman at Nordstrom's getting a bonus at the end of the year. So, why should I be paying a much lower tax rate than an average guy earning a bonus? It makes no sense.

  • PAUL SOLMAN:

    Fellow hedge funder Jim Chanos puts it more colloquially.

  • JIM CHANOS, Kynikos Associates:

    It's complete baloney. Economically, I can tell you, as someone in the industry, there is no basis for it.

  • PAUL SOLMAN:

    But the private equity industry says, we streamline businesses, we reorganize them, we make them more productive. So, you want to tax us at a low rate in order to facilitate our rebuilding of corporate America.

  • JIM CHANOS:

    And that's fine. That's great if it happens. But if you earn a fee for doing that, that's actually ordinary income.

    RYAN ELLIS, Americans for Tax Reform: It's not ordinary income, and it shouldn't be taxed that way.

  • PAUL SOLMAN:

    After all, argues Ryan Ellis of Grover Norquist's Americans for Tax Reform, this is all perfectly legal.

    We tried unsuccessfully to find a money manager to defend the carried interest tax break.

  • RYAN ELLIS:

    Under our system of partnership law, you do not have to invest money personally in order to derive a capital gain from the partnership.

    Public policy is all about, do we want to have flexible partnership arrangements that allow for investment partnerships to develop, allow for the successful business arrangement to happen, and that treats capital gains as they're supposed to be treated, capital gains?

  • PAUL SOLMAN:

    Ellis uses an argument the private equity industry makes in its video.

  • RYAN ELLIS:

    Let's say you have two people that want to buy a restaurant, and one of them is a brilliant chef and he will make the restaurant work, but he has no money to invest? And then you have a money investor. They go 50/50 on this restaurant. They eventually sell the restaurant. Are you telling me the brilliant chef shouldn't benefit from the capital gain, that he should pay ordinary income tax on that, that he put nothing into it?

  • PAUL SOLMAN:

    But Morris Pearl doesn't buy the sweat equity argument.

  • MORRIS PEARL:

    Everyone else invests their labor in making money. I don't see any reason why this small group of people, who happen to be hedge fund managers, should pay lower taxes on their labor than everyone else pays.

  • PAUL SOLMAN:

    Pearl is sure partnership law wasn't written to be exploited by money managers. And, in fact, there's a bill now in Congress to exclude carried interest as capital gains.

    That has the staunchly anti-tax Ryan Ellis worried, that it will embolden tax hikers to go after the capital gains tax break next, and who knows what else.

  • RYAN ELLIS:

    This is the camel's nose under the tent, this is the tip of the spear, this is the Trojan horse. Whatever metaphor you want to use, that's what actually going on here.

    I think it is populism at its worst and ugliest, because what it's doing is picking out a very small slice of Americans that earn long-term capital gains and saying, for you and only you, we're going to raise your taxes and tax you as ordinary income. It's pitting Americans against each other. That's absolute class warfare.

  • SEN. BERNIE SANDERS, Democratic Presidential Candidate:

    We have seen a proliferation of millionaires and billionaires.

  • PAUL SOLMAN:

    And on the campaign trail this fall, the camel has sounded surprisingly bipartisan. Bernie Sanders and Hillary Clinton are against the carried interest tax break, of course, but even some Republicans have spears in their tax plans.

  • DONALD TRUMP, Republican Presidential Candidate:

    The hedge fund guys won't like me as much as they like me right now. I know them all, but they'll pay more. I know people that are making a tremendous amount of money and paying virtually no tax, and I think it's unfair.

  • PAUL SOLMAN:

    So, is the carried interest tax break toast?

  • WHITNEY TILSON:

    I think, at best, 50/50 chance that anything changes in the next couple of years.

  • PAUL SOLMAN:

    The only plausible hypothesis here is that people who have a major interest in the carried interest deduction are influencing politicians to not end it.

  • JIM CHANOS:

    I know that sounds shocking, but yes. Anybody with any sense of fairness in tax policy would argue that it shouldn't exist, and yet it hangs on.

  • PAUL SOLMAN:

    Which is why the Hedge Clippers will probably be back in Connecticut again before long.

    This is economics correspondent Paul Solman, reporting for the PBS NewsHour from the front in the war over the carried interest tax break.

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