Obama’s deficit plan hikes tax on carried interest for VCs, hedge funds

February 23, 2009 | Camille Ricketts | Comments | |

As part of his strategy for reigning in the federal deficit, president Barack Obama plans to raise taxes on carried interest for a wide range of hedge funds and private equity managers, according to officials within the administration. The rate would jump from 15 percent (the usual for capital gains) to the income tax rate of 35 percent, more than doubling the tax investors pay on most of their income. Carried interest can briefly be defined as interest earned on profits from investments (typically 20 to 25 percent), and is largely used to pay general partners at firms.

In this case, private equity includes venture capital. So Silicon Valley’s venture capitalists are included in the group who will pay more taxes under the plan. Back in 2007, VentureBeat editor Matt Marshall endorsed raising the rates.

It’s definitely not a novel idea. Just last year, the House of Representatives approved a bill that would have upped taxes on carried interest, but it was killed in the Senate. Still, this new plan seems to have caught the private equity community by surprise. Many predicted that Obama would level his sights on more pressing problems, considering the drop in taxable profits, according to the Wall Street Journal.

But Obama means business. He recently announced his goal to slash the $1.3 trillion deficit in half (to $533 billion) within the next four years. Certainly, his very expensive economic stimulus package isn’t helping. But he seems confident that raising taxes for those who make more than $250,000 a year (including many hedge funders) — in addition to dialing down spending in Iraq — could go a long way toward closing the gap.

While both Democrats and Republicans opposed a tax increase on carried interest in past years, the loss of credibility on Wall Street has turned executive compensation into a ripe political target. No one anticipates major roadblocks for the plan.

A quick explanation of carried interest, below:

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About the Author, Camille Ricketts

Camille is the lead writer for GreenBeat. She came to VentureBeat from Google where she worked on its traditional platforms team, particularly in TV. Before that, she was a reporter for the Wall Street Journal in New York and London. Follow her on Twitter at @camillericketts, and follow VentureBeat on Twitter at @venturebeat.

With GreenBeat 2009, VentureBeat's all-star conference on all things Smart Grid, coming up in November, Camille will be expanding coverage of this exciting space. Stay up to date by following @greenbeat2009 on Twitter or by becoming a fan of the event on Facebook here.

  • elliottdahan
    Capital Gains should represent a tax break because someone invested/risked their own money.

    Where is the risk when a VC gets a 2% management fee and then gets a no-risk upside on the carry ?

    My current concern is where Bailout money is going to end up. VCs do not support Seed level innovation, they provide growth capital for those Seed level firms with traction. I truly hope that none of the people's money ends up in the pocket's of VCs. We have already seen VCs raise their entry level on SBIR/STTR loans (a firm which is majority owned by a VC firm can receive SBIR/STTR loans).
  • NVCA is lobbying to exempt VCs. And given the amount of cash top-earning VCs like Doerr gave to Obama campaign, this will be not a very exciting way to say "thank you SV". Let's see what happens next.
  • Taxpayer
    Eta Boy Obama.
    These Hedge Fund crooks were able to bribe the entire congress and while all of us were paying full rate on taxes they were paying capital gains tax Rate. As an attitude adjustment tool, get a list of Representatives and Senators who voted for this tax break and publish it!!
  • Stu
    Query for anyone: could this increased rate be avoided by giving management an outright % ownership in any fund they manage right off instead? Is something like this apt to be attempted in structuring new funds? Thanks.
  • common sense
    taxation is taxation: it makes no difference to discriminate between whether the form comes from a return on capital or a return on labor.

    people take risks because there are rewards; if they mismatch between the two- the market should exact consequences. tax breaks that reward marginally greater risk-taking is what lead to the credit crisis.

    that said, entrepreneurs will always be there, to take risks. and simply insulating and even encouraging more risk-takers hampers good entrepreneurs by propping up bad ones. the market saturates and opportunities are diluted.
  • charlie
    I am a VC specializing in early stage companies. These are the most risky kinds of companies which tend to fail 50% despite all the value a VC brings to their opperations. Do you think I would raise another earlier stage fund if the government decides to take another 25% of the profits generated from sales of the successful companies in the portfolio? Why bother. What this change in carried interst taxation will accomplish is far less early stage companies will be funded. Who out there thinks that is a good idea?
  • Good read - keep it up.