How Donald Trump’s Carried Interest Tax Hike Masks a Massive Tax Cut for Wealthy Money Managers

The emerging conventional wisdom on Donald Trump’s tax plan is that it is a trillion dollar giveaway to the best-off Americans coupled with a populist flourish in the form of a small tax hike for the carried interest income earned by hedge fund millionaires.

But even Trump’s so-called populism on carried interest is a fig leaf. What appears to be a small hike for money managers may actually be a major tax cut for this privileged group.

Carried interest is essentially wages that money managers disguise as capital gains to take advantage of a special low 23.8 percent tax rate on capital gains—well below the 39.6 percent current top tax rate on regular income. Trump’s tax proposal would eliminate the carried interest loophole but also drop the top rate on ordinary income to 25 percent. The tax rate on carried interest, then, would marginally increase from 23.8 to 25 percent, a small sum for the hedge-fund millionaires who Trump claims are “getting away with murder.”

This supposed tax increase, however, obfuscates the even larger tax break the Trump plan would give to money managers by creating a new, low 15 percent tax rate for pass-through business income.

Pass-through business income is the money that owners of businesses such as partnerships and sole proprietorships report on their personal income tax forms. The most likely consequence of having a special low 15 percent tax rate on pass-through income is that wealthy Americans, including money managers, will find ways to disguise their salaries as pass-through business income to take advantage of the low rate.

Put another way, the Trump plan creates an entirely new path for hedge fund and private equity money managers to game the tax system. Rather than imposing a 1.2 percent tax hike on carried interest income, Trump’s plan would effectively lower the tax rate on carried interest to 15 percent. Notwithstanding Trump’s claims about working families being taken off the tax rolls, it’s the hedge fund class that will be writing “I win” on their tax forms as a result of this provision.

If the idea of a special low rate for pass-through income sounds familiar, it’s because it has been tried before. Cutting the tax rate on pass-through income was a centerpiece of Kansas Gov. Sam Brownback’s supply-side tax-cutting experiment several years ago. Brownback claimed that a special zero percent tax rate on pass-through businesses would result in a wave of job creation—and, as is now widely recognized, no such wave ever occurred and the provision helped devastate the state’s revenue. 

The bottom line is that Trump’s pass-through tax break would likely make an already unsustainable tax plan even worse. A new Citizens for Tax Justice analysis of Trump’s proposal estimates that the plan would cost nearly $11 trillion over a decade and give the deepest tax cuts to wealthy individuals and corporations. The tax avoidance prompted by Trump’s business tax cuts would likely dig this fiscal hole even deeper.