The carried interest taxation debate just changed
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Yale University has long been a private markets trailblazer and ally, thanks to its alts-heavy endowment model.
- Now it may become a taxblazer, much to the private market's chagrin.
Driving the news: Yale's Budget Lab, a nonpartisan policy research center, recently published an analysis that argues that changing the tax treatment of carried interest could generate over $100 billion in new federal revenue over the next decade.
- And then "substantially more revenue" afterwards.
Why it matters: This may alter the terms of the carried interest debate, which for years has been premised on much smaller numbers provided by sources like the Congressional Budget Office.
- Those advocating for carried interest to be taxed as ordinary income have said it's more about fairness than funding. They now get to argue both.
- Those arguing for carried interest to continue being taxed as capital gains have said the fiscal reward isn't worth the risk of reduced investment. They'll now lean into the second part, even though the Budget Lab also poured some cold water on it.
Zoom in: Yale's Budget Lab based its analysis on anonymized K-1 tax records data obtained by Columbia Law School professor and economist Michael Love.
- This provided much more granular data on a broad set of partnerships, rather than extrapolating from more readily available sources like SEC filings for listed fund managers.
- There still wasn't a carried interest line item, but researchers were able to track "profit allocations in excess of contributed capital."
By the numbers: The $100 billion figure was based on a straight tax treatment change, including for real estate and hedge fund managers who earn carried interest.
- The Budget Lab estimates nearly $88 billion over 10 years from a recent proposal from three Democratic senators, versus earlier $47.5 billion estimates, while a more modest proposal from former President Biden would have generated $28 billion versus earlier estimates of $11 billion.
- It didn't break out the tax revenue by sub-asset class.
Full transparency: I've argued for more than 15 years that carried interest is a fee for service, and thus should be taxed as ordinary income. Many of you vociferously disagree (some sincerely, some selfishly).
- President Trump also has supported the change, unsuccessfully trying to get it included in his 2017 tax bill, as did former Presidents Biden and Obama.
What they're saying: "The Budget Lab's analysis is fundamentally flawed, failing to account for the real-world impact these proposals would have by constricting economic growth, investment, and tax revenue," says Will Dunham, president and CEO of American Investment Council. "It tells us more about the group's pro-tax ideological biases than the actual policy impact."
- Natasha Sarin, president and co-founder of the Budget Lab and a Yale Law School professor, replied: "We anticipated industry pushback and I'm not super swayed by the nature of critiques they've levied ... They've mentioned that we don't account for behavioral response to closing the loophole, but we explicitly did ...
- Sarin continues: "One valid critique is that we're extrapolating based on the industry's historical size, and not assuming outsized returns due to things like big AI returns. My view, therefore, is that our estimates may actually be a significant lower-bound."
The National Venture Capital Association — which like the AIC has lobbied to maintain capital gains treatment — didn't return a request for comment.
The bottom line: There's a new challenge to the status quo.
