Carried Interest- Political Optics, Revenue Impact

On the news you may hear about a topic on Trump eliminating the carried interest loophole on fund managers.

The loophole is much more of a political debate than a revenue game-changer. The left frames it as closing a loophole that benefits wealthy fund managers, while the right often argues that it discourages investment and entrepreneurship.

It will be expected to raise, according to the CBO, $12-$15 Billion in tax revenue in Ten Years!

In the grand scheme of federal spending, $12-15 billion is barely a rounding error. The U.S. government spends roughly $6.5 trillion a year, which breaks down to about $12.3 million per minute—so carried interest reform would barely cover a few hours of government operations.

Carried interest has a long history, dating back centuries, but its modern form is closely tied to the rise of private equity, venture capital, and hedge funds. Here’s a breakdown of its origins and evolution:

1. Early Origins (Medieval Times – 19th Century)

• The concept of carried interest is believed to have originated in the 16th and 17th centuries with merchant voyages and ship captains.

• Investors would fund trade expeditions, and captains would receive a percentage of the profits (often 20% of the earnings after repaying investors)—essentially an early version of the modern carried interest structure.

• This practice carried over to land-based investment ventures, including mining and real estate, where managers of these projects took a cut of the profits.

2. Early 20th Century: Real Estate & Oil Partnerships

• The real estate and oil industries used a similar model in the early 1900s, where investors provided capital and project managers earned a share of the profits as an incentive.

• This became an accepted method of aligning interests between those providing capital and those managing the investments.

3. Mid-20th Century: Rise of Private Equity & Venture Capital

• The modern version of carried interest emerged with the growth of venture capital (VC) and private equity (PE) funds in the 1940s and 1950s.

• Investors (limited partners) provided capital, while fund managers (general partners) managed the investments, typically taking a 20% cut of profits as carried interest.

• The practice gained widespread use in the 1980s and 1990s as leveraged buyouts (LBOs) and venture capital funds exploded in popularity.

4. The Tax Debate (2000s – Present)

• Why is carried interest controversial? Because it’s taxed at the long-term capital gains rate (typically 20%) rather than ordinary income rates (which can be as high as 37%).

• Critics argue this is a loophole that unfairly benefits wealthy fund managers, while defenders say it incentivizes long-term investment and risk-taking.

• The debate heated up in the late 2000s, especially during the 2008 financial crisis, when politicians began calling for higher taxes on Wall Street.

• Reforms have been proposed repeatedly, but the industry has successfully lobbied against major changes.

• The 2017 Tax Cuts and Jobs Act made a minor adjustment, requiring a three-year holding period to qualify for capital gains treatment—but it didn’t eliminate the lower tax rate.