During every U.S. presidential election season, at least one candidate vows to repeal carried interest deductions. Meanwhile, venture capitalists do their part and argue against it. The issue is near and dear to their hearts because carried interest treats investment partners’ salary as an investment and not income, taxing it at long-term capital gains rates and not as ordinary income (which is taxed more heavily). Many VCs also believe they deserve the tax break for taking risks and holding on to assets for what often becomes many years on end.
The National Venture Capital Association, which represents venture firms’ interests, is very much atop the issue again this election season. It issued a statement earlier today calling Democratic presidential nominee Hillary Clinton “misguided” after she presented an economic plan at a manufacturing company in Warren, Michigan that called for the repeal of carried interest. The NVCA also published a release on Monday, after Republican nominee Donald Trump presented a plan in Detroit that similarly suggests doing away with carried interest. It would “threaten [the] entrepreneurial ecosystem,” said the NVCA.
Still, you aren’t seeing much outrage on the part of individual VCs, and we have a few theories as to why.
Let’s start with Trump, whose tax plans have even top academics confused by what, exactly, he is proposing. (“It’s very hard to figure it out,” said Harvard Business School professor Josh Lerner when we called him earlier this week to discuss it.)
Part of the problem: While Trump is proposing ending the taxation of carried interest at long term capital gains rates (which are currently around 23.8 percent), and instead proposing it be taxed at 33 percent, which is the highest marginal tax bracket in his plan, Trump has thrown a separate wrench into the works. Specifically, he has said he wants a new 15 percent business tax for members of partnerships and other pass-through business entities.
This might give VCs reason to cheer, except that the tax is so low that pretty much every business in the U.S. would restructure itself into a pass-through business if it came to fruition, quickly destroying the economy. (Kansas passed a similar law in 2012. Now Bill Self, the head coach of the University of Kansas’ men’s basketball team, who reportedly makes more than $2.75 million a year, pays almost no income tax because he receives the bulk of his annual compensation through an LLC.)
A Washington, D.C., tax specialist who asked not to be named calls it “not remotely practical when you consider the deficit challenges going forward. In fact, I don’t see any way for what [Trump] is proposing to be put into place. It’s so far to go from here to there as to render [his plan] little more than an aspirational blueprint.”
What about Clinton? She has been clearer about her proposal around carried interest, as well as her plans to tie more attractive capital gains rates to longer holding periods.
For example, right now, assets that are held for more than one year are considered long-term gains. Clinton wants to push that out to two years. More, the current long-term capital gains rate of 23.8 percent would only apply to assets held for six or more years. Not last, Clinton says she wants to tax carried interest as ordinary income, and unlike Trump’s top rate, which he has capped at 33 percent, Clinton’s is 43.4 percent.
Given Clinton’s lead in the polls, VCs may well grow louder about these aspects of her economic plan as the election nears.
As Menlo Ventures managing director (and current NVCA president) Venky Ganesan tells me, “Taking on carried interest interest is a very populist thing. In most minds, it’s associated with hedge funds and private equity funds, which are Public Enemy No. 1.”
But Ganesan predicts unintended consequences, saying that just one concern centers on access to capital for entrepreneurs in geographies where there isn’t a whole lot already. “In Oklahoma and Tennessee and other places [that are trying to nurture tech entrepreneurship], people might well say, ‘If I’m going to be taxed as much as a hedge fund, why start a fund? It’s not worth the risk.'”
Yael Hochberg, an associate professor of entrepreneurship at Rice University, understands Ganesan’s point, but she suggests that historical concerns over doing away with carried interest — including that costs will be passed on to VCs’ institutional investors in the form of higher fees and higher carry (which in turn may stifle their investment in VC funds) — could be overblown.
“Personally,” she says, “I expect the lawyers will simply find a different way to structure VC comp — i.e., partnership agreement revenue sharing arrangements — such that this is circumvented. I’ve spoken to a few lawyers at big shops who claim to already have new structures ready and waiting in their desktop drawers.”
Hochberg also notes that while both candidates are taking on carried interest, the GOP is perfectly happy with the status quo, and Republicans currently control both the House and Senate.
More, as Hochberg, recalls, according to the president’s Office of Management and Budget and Congress’ Joint Committee on Taxation, even a blanket increase of taxation on capital gains to ordinary tax rates would result in only $1 to $2 billion per year in additional tax revenue out of $3.4 trillion in revenue collected every year.
Put another way, “It’s politically expedient to talk about. But I think there are bigger and better things for the candidates to focus on after the election,” she says.
Judging by how quiet is it out there, VCs who’ve been through an election cycle or two seem very much to agree.