Magnitude of Wealth Created by Carried Interest Structure

So, Professor, one of the things that I think we you've contributed in your study actually is to quantify how much money Treasuries, United States Treasury, UK Treasury elsewhere are giving up because of this special income tax treatment for carried interest. How big a number is it? So it, it, it's for carried interest. I calculated I, I, I, I leave the, the tax question to, to, to tax specialist. But the the amount of carry that has been earned, paid and due is $1 trillion at minimum. That's the one for which we know how to calculate it. The total magnitude could very well be twice as much because we don't have the data for every vehicle out there. But for this firms here that you have on your screen, we will know about all their fonts. And so we are quite sure that these numbers are pretty close to what they have historically in Carrie. So I guess it must be Occam's razor when we asked the question, why doesn't anything get done about this? Is it just because these people that get carried interest benefits are extremely wealthy and have enough money to influence what congressman and the senators do? That's that's one view, baby. Certainly by now I think priority is the largest lobby in in in the US Senate. But it's it's like not in every country in the world. So it looks like there is something that, you know, that's quite clever about the legal structure that means that carrier has been accepted as a capital gain in about every country in the world and, and it's, but it's disputed. I I think outside our practical industry, nobody really understand or believe that it should be a capital gain. People in the practical industry pretty very hard should be their lawyers have successfully argued that it should be. And so about every country in the world has has taxed it this way. We have seen in succession in the US Barack Obama saying he would change that. Then even Donald Trump said he would change that and none of them have done it. Everybody has maintained carry a tax as a capital gain. So Professor, I suspect if someone from Blackstone, another private equity firm were here, they'd say, wait a second, this is not an expense to the taxpayer. This is actually capital investment, because by having this preferential treatment, you're actually encouraging investment in new ventures. What do you say to this is actually an investment in a growing economy? Yeah, you can make this argument. One of the benefits of doing this calculation, which nobody had done before is that you can actually look at how much of A carry is going to small venture capital firms. So the people who are defending carry preferential tax treatment often say this is to like, you know, enable innovation. You have all these venture capital funds that are essential for the American economy to grow. And therefore we need to be very kind to the people running these funds and give them a, a, a special tax treatment. The thing is that when my numbers are showing is that 7% of these anti carry pool is going to venture capital. And if you would further restrict it to small venture capital funds, you'll be 3 or 4%. So most of the carrier is going to a fence you have just shown and a lot more I guess. And they are not in the business of like small companies, early stage venture capital investing. They are in the business of buying out Hilton hotels to buy out TXU like to buy out like large companies. I'll drop back to an incredibly basic question and just ask, and I'm sure you've researched this or you know, your economic forefathers have researched it to death, but why tax capital gains any different than you tax regular income? I mean, does an investor really provide that much more of an impetus to grow the economy than a factory worker? Yeah. So it's it's it's a very good question. It's it's again, it's hard to understand. Like nobody who who's earned being taxed on an income like me has difficulties to understand why. But everybody was was subject to capital gain taxes. Think it makes complete sense. So it it the idea of what often we hear that is because it's capital at rest. You you could have earned or you could have lost the money. And so because it's uncertain, it shouldn't be taxed the same way as something that is certain. But said when you earn a bonus as a banker, it wasn't certain. You were not sure to get it. And yet you pay income taxes on these bonuses. And so this argument of like it's it's uncertain income and should be taxed differently doesn't seem to really fly. So it is indeed a very good question about why there are two different tax rates. An over answer for for why it is that sometimes when people tax on capital gains, they don't adjust for inflation. And because an average raise inflation, it would be unfair to tax it like like income. And so instead of doing an inflation adjustment, you just tax it at a lower rate. But then it means like in times of low inflation, then it's like a very weird way and a very big tax credit you have given to people. And when there is high inflation, it's not even enough. So the Army's arguments floating around, but they're a bit odd. They're not that great spurring up. So, Professor, apart from fairness questions, what about what does history teach us about the incentive to invest more? I mean, we've gone up and down and all around with capital gains rates in the United States. Is there a pattern that you can discern that when we cut the capital gains rate that actually we get more capital invested? The, the, the carry here is about what the fund manager is earning. So it, it's not really affecting the capital going in. So the capital going into priority equity is coming from CalPERS, it's coming from family offices, coming from endowments and the like. The increase in, in, in taxes shouldn't really affect them. So unless you have in mind that because the fund manager is going to be taxed and carried interest, the current interest will move from being 20% to being 35%. And then you can say, well, and many is the patient funds that they're going to pay for it. And so they're going to invest less in priority equity. And if you believe that practically is good for society, then you think it's it's it's a problem. You you could do the you could reason this way, but it's important to know that the carried interest is really the the tax. It's it's what the fund manager earns has pocket money for having performed well. It really is a bonus for performance. And so you know, how this is taxed are clearly shouldn't really massively affect flow of capital to venture capital or, or, or buyout. You start out this conversation by telling us that carried interest is taxed essentially the same across all all different regimes. Do you see any chance of that changing in this important election cycle that we're facing right now? It's a very interesting historical thing to study in Sweden a few years ago, it went all the way to Supreme Court and and then the Supreme Court and and they they have lost at every stage. So it was said, you know, there's no way you keep this as a capital gain. And at the, and the Supreme Court said, no, it's it, it remains a capital gain. We have seen some countries increasing a bit the rate, acknowledging that it's not really a capital gain. So like in the UK, they say if it's a pure capital gain, it's 20% taxes. This one is not really a capital gain. So it's going to be 28%. You, you have the Netherlands at 33%. So you have some countries that went then middle of the road type of things or that they make it conditional on how much money the fund manager is putting in their own fund or things of a sort. So I think that, and we see it in the UK this week where they first announced we're just going to tax it like any other income. And then just today they announced that, well, you know, if, if people really put their money into their fund, then they will be excused. And then we will maintain it as like a lower gain as a lower tax rate. So I, I, I know history is teaching us, but no one has really managed to move it. And again, like even Trump wanted to change it and then and then didn't. So but the biggest donor of Trump is, is, is Steve Schwarzman. And that's one of the largest owner of carried interest. Money talks.