Pascrell Tries to End Big Tax Break for Wealthy Investment Managers

John Reitmeyer | March 20, 2019 | Budget
Proposed legislation would change how federal government treats ‘carried interest.’ Congressman says no place for a ‘parallel tax code’ for the rich

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A veteran New Jersey congressman, seizing on frustration with major federal tax-policy changes enacted by President Donald Trump, is trying to whip up new momentum for ending a lucrative tax break enjoyed by many Wall Street fund managers.

Legislation introduced earlier this month by U.S. Rep. Bill Pascrell (D-9th) would change how the federal government treats so-called “carried interest” collected by private-equity and hedge-fund investment managers by classifying those profits as personal income instead of capital gains.

Last year, Gov. Phil Murphy enacted legislation at the state level that also targeted carried interest, and initial estimates suggested the state could collect as much as $100 million annually by levying a 17 percent “carried-interest fairness fee” in New Jersey. The 17-percent rate was intended to bridge the gap between the federal capital-gains and personal-income tax rates. So far, New Jersey’s new levy has yet to generate any revenue for the state budget pending action in several nearby states.

Pascrell’s carried-interest bill would also hit fund managers by forcing them to pay federal taxes at the much higher personal-income rates than they do under current federal tax law. But the push by Pascrell, if it’s successful, could also further delay implementation of the carried-interest fee in New Jersey due to the way the new state law was written.

This isn’t the first time carried interest has been targeted for reform at the federal level; similar proposals have been supported in the past by politicians from both parties, including the Republican Trump. But carried interest was left out of the major tax overhaul that Trump signed into law in late 2017, even as rates were cut for corporations and individuals, and as rules related to personal exemptions and deductions were also changed — including the write-off for state and local taxes known as SALT that’s cherished in New Jersey.

Pascrell: ‘badly skewed’ tax code

Some initial reports have suggested many taxpayers, including those in high-tax states like New Jersey, are seeing reduced refunds as they submit income-tax returns for 2018 in advance of next month’s Internal Revenue Service filing deadline.

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U.S. Rep. Bill Pascrell (D-NJ)
“Millions of Americans filing their taxes are finding that the refunds they anticipated will not materialize this year,” Pascrell said. “They and many other Americans are rightly outraged at a tax code that is badly skewed to favor some of our wealthiest citizens and corporations.”

The lower capital-gains tax rate that is currently assessed on the profits earned by investment managers was established decades ago to encourage investment in categories like stocks and real estate that can produce an overall benefit for the national economy. But many now view the policy as a tax loophole that forces secretaries on Wall Street to pay higher tax rates than their executive bosses.

Pascrell said the tax break is also subject to abuse by Wall Street investment managers who use it to buy companies and then secure profits from dismantling them. It’s also enjoyed by outside fund managers who have been hired by New Jersey’s public-employee pension system to handle a portfolio of so-called alternative investments. The fund managers often charge the state lucrative fees to actively manage those investments even while being taxed at the passive, capital-gains rate.

If the profits earned by the fund managers were taxed as personal income instead of as capital gains, as Pascrell’s bill proposes, they would likely be subject to the 37 percent top-end federal income tax rate. Instead, the rate ends up being between 15 percent and 20 percent, based on the federal government’s capital-gains tax code.

Critical of ‘special breaks and deductions’

“Certain wealthy taxpayers should not have their own parallel tax code of special breaks and deductions,” Pascrell said.

A number of fellow Democrats have signed on as co-sponsors of the legislation in the U.S. Senate, including Tammy Baldwin of Wisconsin and Elizabeth Warren of Massachusetts. Pascrell and the other bill sponsors argue such a policy change is a matter of fairness. Projections from the nonpartisan Congressional Budget Office suggest it would also generate an estimated $14 billion in new revenue for the federal budget over the next 10 years.

While Trump promised as a candidate in 2016 to establish higher tax rates for carried interest, the lack of action on the issue at the federal level has inspired several reform efforts in the states. They include in New Jersey where Murphy, a Democrat, established a new tax on “investment management services income” as part of the fiscal 2019 state budget signed into law last July.

But Treasury officials noted last week that the policy change has yet to generate any revenue due to language in the bill that also requires several other states to take similar action before the new fee can be levied in New Jersey. Sponsors added that language to prevent the fund managers from simply changing the address of their investment businesses to avoid the new state tax in New Jersey. However, with no similar legislation having been passed to date in those other states — Connecticut, Massachusetts and New York — the New Jersey tax remains on hold.

Meanwhile, the legislation enacted by Murphy also included a provision that would stop the proposed state-level investment-management levy from going into effect if the federal government eventually enacts a measure like the one proposed by Pascrell.