Hillary Clinton's 2016 Contributions from Wall Street

by Wayne Flaherty

Whatever her populist pitch may be in the 2016 campaign — and she will have one — note that, in all these years, Hillary Clinton has not publicly condemned Wall Street or any individual Wall Street leader. 

It’s “just politics,” said one major Democratic donor on Wall Street, explaining that some of Clinton’s Wall Street supporters doubt she would push hard for closing the carried-interest loophole as president, a policy she promoted when she last ran in 2008.

Carried Interest

How The Industry Works - (What is carried interest?)

Hedge funds, private equity firms and similar vehicles are typically structured as investment partnerships. The managers, collectively, are the “general partner.” Outside investors like pension funds and wealthy individuals -- the “limited partners” -- fork over hefty sums, trusting the partnerships to grow their wealth. Private equity firms restructure companies in order to extract greater profits from them. Hedge funds strategically buy and sell assets. After a time, the original pension funds and wealthy individuals get their money back -- plus whatever gains the investments accrued, minus fees.

In both cases, the fee structure usually looks something like “2-and-20”: The general partner takes an automatic 2 percent cut on the investments, plus an additional 20 percent incentive fee of whatever additional gains they realize over benchmarks. The 2 percent is treated like ordinary income and taxed accordingly. But the 20 percent incentive fee is often deemed “carried interest.” Through a quirk in the tax code, incentive fees are allowed to be taxed a rate some 20 percent less than they would as income.

Why Carried Interest Is Different

Although incentive fees are structured to reward investment managers for their hard work, the income is treated as “capital gains,” not earnings derived from labor. Capital gains are simply the appreciation of any asset you own that gets more valuable. If you buy a share of XYZ Corp at $20 and sell it next year at $30, you will owe a 20 percent capital gains tax on that $10 difference. By characterizing the carried interest fee as a capital gain -- and not a fee for a service rendered -- hedge fund and private equity managers successfully avoid much higher income taxes, which max out at 39.6 percent.

What Do Experts Think?

Defenders of the carried interest rule argue that it promotes entrepreneurial risk-taking. Venture capitalists go out on a limb supporting early stage companies, they say. By treating subsequent profits as carried interest and not income, the tax rules encourage investors to put their capital to productive use. In an op-ed defending the arrangement, Private Equity Growth Capital Council CEO Steve Judge wrote, “The capital gains rate exists to provide incentive for investment partnerships to take risks, invest hundreds of billions of dollars of capital into new and existing businesses and contribute operational expertise to improve these businesses over time.”

But many tax professionals are not convinced. According to the Tax Policy Center, "Few, if any, analysts believe that carried interest represents entirely a return to capital rather than labor." “I think it’s odd that people making that much money off of essentially labor income should be paying lower rates than…their secretaries are, to put it baldly,” Michael Graetz, deputy undersecretary of tax policy for George H.W. Bush, has written.