The Mitt Romney Loophole

The basic principle underlying progressive taxation is that, generally speaking, the more you make, the higher your tax rate. The fiscal cliff deal passed last week made the tax code more progressive in one way by raising income tax rates on the wealthiest Americans, but unfortunately there remain numerous egregious examples of how our tax code is rigged in favor of the privileged few at the expense of middle-class workers.

Exhibit A in this rigged game is what we’ll call the Mitt Romney Loophole, a special giveaway that exclusively benefits private equity and hedge fund managers. In wonk speak, it’s called the “carried interest” loophole. We’ll let our Center for American Progress colleagues explain:

The carried interest loophole allows people who manage investment funds—such as private equity funds and hedge funds—to convert their income into lower-taxed capital gains.

Here’s how it works: The partners in businesses that manage pools of money on behalf of investors are paid in two ways. One part of their income is a “management fee” for managing the investments. This fee is generally taxed as ordinary income, according to progressive tax rates that currently top out at 39.6 percent. The other part of the fund managers’ income is their cut of the fund’s profits. The fund managers treat their part of the fund’s earnings as a capital gain, subject only to a top rate of 20 percent.

Investment managers, who include some of the world’s richest people, typically take a management fee equal to just 2 percent of the assets they manage—plus a 20 percent cut of their investors’ profits. In doing so, they are able to shield the bulk of their income from ordinary tax rates.

(You can find a more detailed explanation HERE.)

Lower tax rates on capital gains and dividends already disproportionately benefit the wealthiest Americans, but the Mitt Romney Loophole goes above and beyond that by allowing a narrow category of often extremely wealthy individuals to unfairly avoid paying their fair share.

This loophole is one of the main reasons that Mitt Romney paid a tax rate of just 13.9 percent on income of more than $20 MILLION. Meanwhile, millions of middle-class workers pay a much higher rate on their much, much lower salaries.

Closing this loophole would not only make our tax code fairer and more progressive, it would help raise the revenue that we need in order to protect vital programs and leave room in the budget for investments to grow the middle class. Closing just this one loophole that often benefits the ultra-wealthy would raise $21 BILLION over ten years.

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Advocacy Team