Accumulated interest loophole survives another political battle

WASHINGTON — Once again, vested interest has triumphed.

Senate Democrats’ last-minute removal of a provision in tax and climate legislation that would reduce what is widely known as the “earning interest loophole” represents the latest victory for the private equity and hedge funds. For years, those companies have successfully lobbied to strike down bills that aimed to end or limit a quirk in the tax code that allows wealthy executives to pay lower tax rates than many of their salaried employees.

In recent weeks, it looked like the benefit might be cut, but a last-minute intervention by Arizona Democratic Sen. Kyrsten Sinema scrapped what would have been a $14 billion tax increase targeting private equity.

Lawmakers’ failure to address a tax break that Democrats and some Republicans have said is unfair underscores the political power financial industry lobbyists wield and how difficult it can be to change a tax code that members of both parties they call inequitable.

In addition to ending the accrued interest provision, the deal Democratic leaders made with Sinema included a 1 percent excise tax on share buybacks and changes to a minimum 15 percent corporate tax that favored manufacturers.

On Friday, the private equity and hedge fund industries applauded the development, describing it as a victory for small businesses.

“The private equity industry directly employs more than 11 million Americans, feeds thousands of small businesses and offers the strongest pension returns,” said Drew Maloney, executive director of the American Investment Council, a lobbying group. “We encourage Congress to continue to support private equity investment in every state in our country.”

Bryan Corbett, Executive Director of the Managed Funds Association, said, “We are pleased to see that there is bipartisan recognition of the role that private equity plays in growing businesses and the economy.”

Accrued interest is the percentage of an investment’s earnings that a private equity partner or hedge fund manager receives as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is around 20 percent.

Under existing law, that money is taxed at a 20 percent capital gains rate for top earners. That’s about half the rate of the top bracket of individual income tax, which is 37 percent. A 2017 tax law passed by Republicans largely left the accrued interest treatment intact, after an intense lobbying campaign, but narrowed the exemption by requiring executives to hold their investments for at least three years to enjoy a preferential tax treatment.

An agreement reached last week by Sen. Joe Manchin III, a Democrat from West Virginia, and Sen. Chuck Schumer, the majority leader, would have extended that tenure period from three to five years, while changing the way that the period is calculated in the hope of reducing taxpayers. ‘Ability to game the system and pay the lowest tax rate of 20 percent.

But Ms. Sinema, who has been collecting political donations from wealthy financiers who usually donate to Republicans and was cool to the idea of ​​targeting interest generated last year, balked.

Over the past five years, the senator has received $2.2 million in campaign contributions from investment industry executives and political action committees, according to Open Secrets. The industry was second only to retirees in giving to Ms. Sinema and just ahead of the legal profession, which gave her $1.8 million.

For years, accrued interest has been a fiscal policy piñata that is never opened.

During the 2016 presidential campaign, Donald J. Trump said, “We will eliminate the accrued interest deduction, the known deduction, and other special interest loopholes that have been so good for Wall Street investors and people like me, but unfair to the Americans. workers.”

When President Biden ran for president in 2020, his campaign said he would “eliminate special tax breaks that reward special interests and close the capital gains loophole for billionaires.” To do that, he said he would tax long-term capital gains at the maximum ordinary income tax rate, essentially eliminating the special treatment of accrued interest.

A similar proposal appeared in Biden’s budget last spring, but when Democrats tried unsuccessfully to pass his “Build Back Better” legislation in the summer and fall, interest fizzled out.

Jared Bernstein, a member of the White House Council of Economic Advisers, lamented that the lobbyists had won.

“This is a loophole that absolutely should be closed,” Bernstein told CNBC last September. “When you go up to the Capitol and start negotiating on taxes, there are more tax lobbyists in this city than there are members of Congress.”

There are close ties between the Democrats and the private equity industry in general. Michael Shapiro, a lawyer who is married to Mr. Schumer’s daughter, recently left a job with the Transportation Department and joined investment giant Blackstone in June as director of government affairs.

“Senator Schumer is a long-time advocate for closing the interest-earning loophole and his support for doing so is unquestioned,” said Justin Goodman, a spokesman for Schumer. “He worked to the end to try to keep the provision in the legislation and will continue to look for opportunities to remove it.”

Matt Anderson, a Blackstone spokesman, said Shapiro “will not engage in any defense to the Majority Leader or his office related to Blackstone business.”

Some analysts were skeptical all along that lawmakers would actually change the tax treatment of interest earned in the final bill. While it has become a high-profile target, the change Democrats sought would have raised relatively little tax revenue compared to other provisions of the legislation, known as the Inflation Reduction Act.

Accumulated interest has become the MacGuffin of the IRA saga,” said James Lucier, an analyst at Capital Alpha Partners, a policy research firm in Washington, describing it as a literary device authors include simply to make plots more interesting. “The MacGuffin distracted from the really important things that happen in the story to make the shocking conclusion even more shocking at the end.”

Ms Sinema herself has said little about the legislation or why she considered it so important to preserve the tax treatment of accrued interest.

“We have agreed to remove the accrued interest tax provision, protect advanced manufacturing and boost our clean energy economy in Senate budget reconciliation legislation,” he said in a statement Thursday.

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