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Hedge Fund Industry Protected Tax-Saving Loophole

Richard E. Cohen February 14, 2018

“Carried interest” provision puts billions into the pockets of Wall Street’s wealthiest players

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“It’s going to be a tremendous thing for the American people,” President Trump proclaimed as he signed the new tax cut into law.

But he apparently failed to remember a firm promise that he repeatedly made during his presidential campaign to eliminate what he contended was an abusive rip-off in the tax code. Referring to an arcane provision called “carried interest” that provides nearly $2 billion annually to a handful of super-wealthy hedge fund managers, Trump said during an August 2015 interview on CBS’s Face the Nation, “They're paper pushers. They make a fortune, they pay no tax. It's ridiculous, OK?”

According to Forbes, managers and traders of the 25 largest hedge funds earned $11 billion in 2016.

Produced by Joey Rettino

Even before candidate Trump weighed in, the carried interest provision was renowned as a symbol of how mega millionaires enjoy a haven in the income-tax code that is not available to the working class, or even to conventional stock-market investors. In simple terms, hedge-fund managers have listed much of their routine proceeds as “capital gains,” rather than as ordinary income. Prior to the recent tax cuts, that tax break gave them a capital gains tax rate of 20 percent, compared to the top rate of 39.6 percent for individual taxpayers.

The new law introduces a new holding period for the carried interest income of three years. Beyond that, it leaves the perk relatively untouched and allows some of Wall Street’s highest earners to pay a lower tax rate than many blue-collar Americans.

Mighty tax dodge

“President Trump promised to eliminate the carried interest loophole,” Minority Leader Nancy Pelosi told the House during debate on the final version of the bill. “Yet the Republicans wrote a tax scam that not only continues this outrageous loophole, but it gives even more loopholes to the wealthy and well-connected.”

Not surprisingly, the hedge-fund industry has a team of savvy and experienced lobbyists in Washington to protect its interests. The Managed Funds Association, which calls itself “the voice of the global alternative investment industry,” has been a relentless supporter of the tax break for many years—as part of what it calls its advocacy of “sound industry practices and public policies that foster efficient, transparent, and fair capital markets.”

Some of its most politically active members are Paloma Partners and Soros Fund Management, which are led by Democratic activists, and Renaissance Technologies, which until recently was led by Trump confidant Robert Mercer.

While pursuing intensive backroom contacts with key congressional players, the trade association has been notably wary of raising its public profile. It issued no formal statement during the final weeks of congressional action, though—as final action on the bill was completed—it released a year-end review that voiced relief that many “problematic revenue raisers were not included” in the legislation.

The MFA did not respond to requests for an interview.

The association is led by Richard Baker, its president and CEO since 2008. He previously served as a Republican Congressman from Louisiana, and was an influential member of the House Financial Services Committees. Baker resigned from Congress about a year after his unsuccessful bid to become the senior Republican on that committee. He retains many close connections from his 21 years in Congress.

Richard Baker, CEO Managed Funds Association
Richard Baker, CEO Managed Funds Association

Baker is generously compensated. He earned more than $2.5 million in salary, bonus and benefits in both 2014 and 2015, according to the MFA’s most recent tax filings with the IRS. In addition, each of his top 10 aides received more than $400,000 in 2015.

With its annual operating expenses of $20 million, the association supported a team of nine lobbying firms in 2017. In the first six months of that year, the Subject Matter firm led by veteran Democratic strategist Steve Elmendorf and Fierce Government Relations headed by Republican insider Don Fierce led that pack, with $150,000 each. Baker’s group has reported roughly $4 million in lobbying expenditures in recent years, according to its tax filings.

A recent addition to the carried interest advocates is Mike Sommers, who is president and CEO of the American Investment Council. That group’s mission is “to develop and provide information about the private investment industry and its contributions to the long-term growth of the U.S. economy and retirement security of American workers.”

As the chief of staff to then-Republican House Speaker John Boehner (R-OH) until Boehner resigned in late 2015, Sommers had worked closely with influential lawmakers, including those on the Ways and Means Committee who managed the recent tax bill and its protection of the hedge funds. Prior to the takeover by Sommers in early 2016, the AIC had annual operating expenses of $8 million.

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Money to burn

As an industry, hedge funds contributed or spent roughly $60 million through individuals or political action committees in both the 2012 and 2014 cycles, according to the Open Secrets website operated by the Center for Responsive Politics. Republicans took in slightly more than Democrats. That total soared to more than $200 million in 2016, largely because of the handful of former hedge-fund executives—notably, Tom Steyer and George Soros—who have become prominent liberal activists, threw their support behind Hillary Clinton’s campaign.

Susan Harley, deputy director of Congress Watch for the advocacy group Public Citizen, pushed hard to keep the loophole out of the new tax law, to no avail.

“These massive tax giveaways are for the sole purpose of padding the coffers of campaign contributors. The fact of the matter is it was really putting the desire of a small segment of society over the needs of all of society,” she told Tarbell.

Whatever the partisan dynamics, the hedge funds have continued to display their clout. In their secretive backroom drafting, congressional Republican leaders and tax-writers gave little attention to Trump’s demand to kill the loophole. That shouldn’t have been a surprise. His own Treasury Secretary, Steve Mnuchin, saw no problem with protecting the hedge-fund special interests. He reportedly crafted the “Mnuchin compromise” for the carried interest loophole that preserved more than 90 percent of the status quo, according to Bloomberg.

Gary Cohn, the Administration’s National Economic Council director, lamented the outcome in a post-mortem review. Speaking at a Washington event sponsored by the website, he placed the blame on “opposition in that big white building with the dome at the other end of Pennsylvania Avenue,” aka Congress.

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