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Carried Interest — A Bipartisan Issue

I wrote in my previous post that I would blog on carried interest shortly.

Hedge funds earn income in two ways. First, they charge their customers a management fee, usually something on the order of 1.5 percent. Second, they take a hefty slice of the capital gains earned in successful investments, often 25 percent.

So, say a man has a $1 million account at a hedge fund and, after a very successful year, his account is worth $2 million. The fund would charge him $30,000 as a management fee and take $250,000 as its share of the profits, leaving him with $1,720,000 in the account. Even with the large fees, a 72 percent return on capital in a single year ain’t bad.

But the hedge Fund owners only have to pay tax on their share of the profit at the capital gains rate, 15 percent. Why?

It beats me. Unlike the customer, they have no money at risk (they don’t share in any net losses). It is a pure fee for service, although, to be sure, measured in capital growth. Hedge fund managers don’t deserve a tax break on their fees any more than lawyers, dentists, or, alas, writers do.

But, why didn’t the Democrats, who ran both houses of Congress from 2007 to 2011, bring this to a screeching halt? Good question. Could it, perhaps, have something to do with the fact that hedge fund managers tend to share these windfalls with politicians in the form of campaign and PAC contributions?