Carried Interest Tax Change: Still Fait Accompli

The morning after Barack Obama was elected president, I wrote that the debate over carried interest taxation was effectively over. Obama had promised on the campaign trail to change the treatment of carried interest from capital gains to ordinary income — which in most cases would raise the rate from 15% to 35 percent – and I saw little chance that he’d go back on that word. I also assumed that most people agreed with me, until the following exchange with NVCA chief Mark Heesen, during a 5 Questions here at peHUB:

Dan: One of your big issues over the past two years has been tax treatment of carried interest. Is that still a big priority?

Mark: I think it continues to be an issue, but you were dead wrong when, the day after the election, you basically said that a change to the carried interest tax was fait accompli. We got lots of calls after that column, saying “Oh my God.”

We knew it wasn’t going to happen at that point. You’ll see it brought up again, but in this environment it’s very unlikely you’ll see Congress working on issues that are not huge revenue-raisers. They will not be out there trying to slap the wrists of people they shouldn’t be slapping the wrists of, because there are more important issues to work on at this point.

Well, today’s Wall Street Journal reports that Obama will indeed include the carried interest tax change as part of the budget blueprint being unveiled later this week. The article does not make clear when the proposed change would go into effect, but I’d assume it would be either the 2010 or 2011 tax year.

Regular readers know that I support this change, and it’s probably not worth rehashing the argument. Instead, four quick points:

1. This entire issue first arose when private equity and hedge fund profits were at record-highs. Were it to be made effective for 2008 or 2009 carried interest, however, it would barely merit a rounding error.
2. The article does not say if venture capital profits would be included in the change, although I’d assume they would. The NVCA has tried cleaving itself from the buyout and hedge markets, but legislators seem unwilling to split that baby (see: Hedge Fund Transparency act).
3. Heesen may still be right, in the sense that Congress could punt on this part of Obama’s plan.
4. I wonder if Obama’s proposal could spark a run of private equity exits. Assuming the changes don’t go into effect for 2009, there could be major incentive to sell now rather than later. Kind of like all those family businesses that went on the block last year, after it became pretty clear that capital gains tax rates would increase once the current law expires.