Will a Change in Party Mean a Change in Carry?

As we ruminate over the November elections, many venture investors are asking the same question: Will a change of party control in the U.S. Congress yield a change in the debate concerning carried interest?

Conventional wisdom suggests that a Republican-led House of Representatives would be less likely to increase taxes overall, including the capital gains rate. Yet, as with any public policy issue, forecasting the future is not that easy.

We can be certain of one thing. Tax policy will remain front and center for the next two years, regardless of which party controls either house of Congress. That’s primarily because the country’s deficit crisis isn’t going away.

Therefore, let’s examine some possible scenarios in turn:

1. The Democrats maintain control in both the House and Senate, albeit by slim margins. At first blush, this scenario represents the most danger to current carry rates. After all, proposals to convert carry from the existing capital gains tax rates to ordinary income rates have passed the House three separate times. But moderate Democrats in the House and the Senate have grown increasingly uncomfortable with the potential economic impact of carried interest changes—at least in the form currently under discussion. Alone or with Republicans, this block could force the carry debate back into the context of overall tax reform, rather than reserving it for their increasingly empty “pay-go” toolbox.

We can be certain of one thing: Tax policy will remain front and center for the next two years, regardless of which party controls either house of Congress.

2. We have a Republican-controlled House and a Democrat-controlled Senate. Considered by many to be the most probable scenario, this configuration would likely keep carried interest off the table in any legislation proposed by the House, but would not prevent the Senate from considering it as a potential trade-off in overall tax reform. When debating such broad-based reform all aspects of the tax code—individual, corporate as well as partnership rules—would be examined. At this stage, it is virtually impossible to predict the final combination of increases and decreases that would allow Republicans and Democrats in the Senate to reach consensus. That said, our case for maintaining a meaningful tax incentive for long term investment is a strong one which has been well received by many in the Senate.

3. Republicans win control of both the House and Senate. This scenario is currently a long-shot, but even if it came to pass, it wouldn’t rule out a return of the carried interest debate. That’s because the Obama Administration has repeatedly included revenue from a capital gains/carried interest tax change in its proposed budget. Historically, once an administration stakes a claim to a position like this and wraps it in populist tax-fairness terms, it rarely admits having made a mistake. The President’s veto power in and of itself will mean that tax policy will be subject to negotiations in which the winners and losers are nearly impossible to predict.

The question remains: When might we see a carried interest tax change proposal again? As early as this month, it turns out. A carry proposal could be tacked on to any legislation debated during Congress’s lame duck session That said, if the Republicans do take control of either the House or Senate, it will be difficult for truly controversial legislation to pass. Either way, we are prepared to address any carry proposals that arise.

For a very long time now, many reporters, bloggers, accountants and lawyers have viewed the change of carry tax rates from capital gains to ordinary income as a fait accompli. Here at NVCA we never doubted that the carry battle would be a hard one, but we also understand the legislative process and the importance of educating policymakers about the venture process. With a near-record number of new members in the incoming Senate and House, this education process starts anew. With your help, our arguments regarding job creation, innovation and international competitiveness will continue to win the day.

Jennifer Connell Dowling, vice president of federal policy for the NVCA, can be reached at jcdowling@nvca.org.