Philanthropy and the Carried Interest Loophole

David Rubenstein, a private equity mogul who co-founded the Carlyle Group, gave $7.5 million in 2012 to restore the Washington Monument after the iconic structure was damaged by an earthquake in the summer of 2011 — one of many recent examples of what he calls his "patriotic philanthropy." But Rubenstein, a signatory to the Giving Pledge, also has played a key role in preserving the highly favorable tax treatment given to carried interest — a windfall that has helped transform private equity into one of the most lucrative corners of the financial industry, ProPublica and The New Yorker report.

Since the end of the Great Recession, private equity — a rarified amalgam of investment banking and management consulting — has been on a roll, registering record profits and boasting at least eighteen executives with an estimated net worth of more than $2 billion. At the same time, many have questioned why the industry so lavishly rewards executives whose work consists of using borrowed money to buy existing businesses, loading them up with debt, and then selling them, often at a large profit. And even if no profits are realized from the sale of a business, private-equity firms still get paid: under the "2 and 20" compensation structure that prevails in the industry, firms receive a 2 percent annual fee on assets under management and 20 percent of any profits above a given benchmark. To the chagrin of many, those profits are treated as "carried interest" — a concept that derives, ProPublic and The New Yorker note, from the share of profits ship captains in the Middle Ages received on the cargo they carried — and that today are taxed, as they have been since the 1950s, as if they were capital gains realized from the sale of an actual investment.

Although it struggled at first, Carlyle became, in the 1990s and 2000s, one of the most successful private equity firms in the country — making Rubenstein and his partners very wealthy men. Along the way, Rubenstein, who in the 1970s worked for Birch Bayh, the Democratic senator from Indiana, and then served as a deputy to President Jimmy Carter's chief domestic-policy advisor, became friendly with a broad range of Washington movers-and-shakers, including both President Bushes, James Baker III (President George H.W. Bush's chief of staff and, later, secretary of state), and officials of the Clinton administration.

So when members of Congress — spurred in part by the writings and public pronouncements of Victor Fleischer, a tax-law professor at the University of San Diego School of Law — started to talk in 2007 about changing the preferential tax treatment for carried interest, Rubenstein and other private equity moguls were ready. While it was expected that most Republicans would oppose any change, Democrats who had received significant support from the financial industry, including Sens. Chuck Schumer (D-NY) and Maria Cantwell (D-WA), came in for special attention. By the end of June, the watered-down proposal that made it to the Senate floor was defeated by three votes, and private equity kept its loophole. Indeed, after he was awarded a Carnegie Medal of Philanthropy in the fall of 2015, Rubenstein told ProPublica and The New Yorker he didn't expect any changes to the way carried interest is treated until both parties in Congress sit down to discuss comprehensive tax reform — something House Speaker Paul Ryan (R-WI) recently said is unlikely to happen before 2017, at the earliest.

In the meantime, a system in which a handful of men earn huge fortunes thanks in part to a loophole in the tax code and then use those fortunes to fund their favorite charitable and philanthropic projects while winning the public's esteem for doing so strikes many as more than a little odd, if not perverse. "I don't want to bash the philanthropy [of moguls like Rubenstein], because it does good," said Fleischer. "But we're creating what’s essentially a parallel system, where a small number of individuals control quasi-public spending, and that will reflect their values and not democratic values....It's great that he's helping out with the Washington Monument. But, if we had a government that was better funded, it could probably fix its own monuments."

Alec MacGillis. "How David Rubenstein Helped Save the Carried Interest Tax Loophole." ProPublica 03/07/2016. Alec MacGillis. "The Billionaires’ Loophole." The New Yorker 03/07/2016.