Obama Sets Sights On 'Carried Interest,' Lucrative Tax Break Used By Romney

Chairman and CEO of the The Blackstone Group, Stephen A. Schwarzman, left, gestures while speaking during a television debate entitled "Redesigning the Global Dimensions of China's Growth", at the World Economic Forum in Davos, Switzerland, Friday, Jan. 29, 2010. (AP Photo/ Michel Euler)
Chairman and CEO of the The Blackstone Group, Stephen A. Schwarzman, left, gestures while speaking during a television debate entitled "Redesigning the Global Dimensions of China's Growth", at the World Economic Forum in Davos, Switzerland, Friday, Jan. 29, 2010. (AP Photo/ Michel Euler)

For chief executive Stephen Schwarzman, running the private equity firm Blackstone Group has proven enormously lucrative, bringing him nearly $140 million in 2011. In addition, Schwarzman's job managing vast sums of other people's money has delivered a tax benefit unavailable to people who run other concerns, from car washes to major league baseball teams: the government allows Schwarzman to pay a much lower tax rate on his earnings than almost anyone else.

Though Schwarzman has not disclosed his 2011 tax burden, the law permits individuals to claim much of the income they earn at private equity firms at a rate that is roughly half what they would pay otherwise.

This benefit has made private equity shops among the most desirable destinations on Wall Street. The profits are big, and the tax bill is small. Now, however, that favored treatment is in the sights of the Obama administration and Democrats in Congress. They have identified this so-called "carried interest" perk -- which costs the Treasury about $1.3 billion a year -- as the sort of arrangement that must be eliminated to close federal budget deficits and restore fairness to the tax code.

"There is no doubt we need additional revenue, coupled with smart spending reductions, in order to bring down our deficit. And we can do it in a gradual way so that it doesn't have a huge impact," Obama said in an interview with CBS on Sunday.

The U.S. tax code includes hundreds of special interest carve-outs and other breaks that favor one group of taxpayers over the other, but few enjoy the visibility of the carried interest tax break, which permits private equity and hedge fund executives to pay lower tax rates than most middle-class workers.

The loophole allows these firms to treat the fees they charge to manage a client's portfolio -- typically, a one-fifth share of any profits -- as investment income, subject to a lower 20 percent capital gains tax rate than the top 39.6 percent marginal rate. (Prior to the fiscal cliff deal reached earlier this year, the top capital gains rate was 15 percent, and the maximum marginal rate was 35 percent).

The private equity firms have defended the low rate they pay as fair given the risks involved with investing. But tax reform advocates have routinely singled the carried interest break out for special scorn, noting that it is investors who carry the risk, not the investment managers.

"[The loophole] has very few defenders except the people who benefit from it," said Rebecca Wilkins, the senior counsel for federal tax policy at Citizens for Tax Justice. "Even CEOs who are paid in stock options or the Super Bowl champs who get bonuses for winning are taxed at the highest rate."

The U.S. Treasury has estimated that taxing investment management income at the lower capital gains rate would cost about $1.3 billion in lost revenue in 2013, and about $13.5 billion over the next decade. This is a tiny amount -- the 2013 budget for the Defense Department is $633 billion, for example -- but it has special political significance. The tax break became a heated issue during the 2012 presidential campaign, when Republican nominee Mitt Romney revealed that he paid an effective tax rate of about 14 percent in 2010 and 2011. Almost all of Romney's income comes in the form of payments from Bain Capital, where he was a partner, as part of his retirement package.

In 2011, for example, he paid $1.95 million on investment income of $13.7 million, for an effective rate of 14.1 percent. That's roughly the same bracket as a worker who earns less than $40,000 per year.

Romney refused to release tax returns from other years.

Billionaire investment guru Warren Buffett has also disclosed that he benefits from the carried interest tax break. He has said that he pays a lower rate on that income than his secretary -- just 11 percent, in 2010 -- and has said he thinks he should pay more.

It is impossible to determine exactly how much other individuals, like Schwarzman, have benefitted from the carried interest tax provision. In 2007, the National Women's Law Center estimated that the Blackstone chief would save $135 million that year. That is enough to fund Head Start services for 19,000 low-income children, the group noted.

In 2011, the most recent year available, Schwarzman received $139 million from his company. That includes a base salary of $350,000, $4.6 million in his share of profits from the firm and an additional $134.5 million from his holdings in Blackstone ownership units, which are similar to stock dividends.

Under the rates in place at the time, Schwarzman would have paid a 35 percent rate on his (relatively) tiny salary, and between 15 and 35 percent on the rest of his income. According to a Blackrock spokesman, Schwarzman gets distributions from the firm that are a mixture of capital gains and ordinary income. "You cannot make any assumptions on the percentage of the two types of income in his compensation," the spokesman said.

Schwarzman has made no secret of his disdain for the president's proposal to eliminate the carried interest break. “It’s a war,” Schwarzman said in 2008 of the struggle with the administration over increasing taxes on private-equity firms, according to Newsweek. “It’s like when Hitler invaded Poland in 1939.”

Schwarzman later apologized for those remarks. Blackstone did not immediately respond to a request for comment.

CORRECTION: The carried interest tax break allows some investment managers to take advantage of a lower capital gains tax rate on their personal income, but the break is not a "deduction" as an earlier version of this story stated.

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