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General partners are compensated for managing their private investment funds through management fees and carried interest. Management fees are consistently around 2 percent of a fund's assets under management and are paid regardless of the fund's performance. Carried interest, alternatively, serves to join the incentives of the general partners with the interests of the limited partners by providing performance-based compensation for the general partners. When a private equity or hedge fund surpasses its hurdle rate of return, usually about 8 percent, the general partners will typically receive around 20 percent of the profits as compensation<ref name="fleischer" />. The general partner in a venture capital fund, on the other hand, will consistently receive 20 percent of the profits as long as the limited partners have received a return at least equal to their contributed capital<ref name ="gilson" />. This 20 percent, in combination with any other profit the general partner may receive from their own stake in the fund, is treated as a capital gain for tax purposes. The 2 percent management fee is treated as ordinary income for tax purposes<ref name="fleischer" />. The maximum rate for a capital gains tax is 20 percent<ref name = "bell" />, compared to the maximum rate for an ordinary income tax of 39.6 percent<ref name = "taxbracket" />.
===The Debate===
Carried interest is an ongoing issue for politicians, the public, and investors alike. Due to the ambiguity of the issue and substantial lobbying on the part of financial institutions, the opponents of carried interest have had little success with policymakers. Opensecrets.org reports that more than $1.1 billion<ref name = "opensecrets" />[http://www.opensecrets.org/industries/totals.php?cycle=All&ind=F] was donated to democratic and republican congressional campaigns by financial institutions in the years 2012 and 2014. Although, presidential nominees Donald Trump and Hillary Clinton have both come out in opposition of carried interest as they advocate taxing capital gains as ordinary income[http:<ref name = "pearl" //thehill.com/blogs/congress-blog/economy-budget/257083-what-the-carried-interest-tax-loophole-reveals-about-our]>.
Those who argue against treating investment funds' profits as capital gains have two primary points:
*The first of which is that carried interest is only taxed when it is realized. Through this tax deferral, the carried interest can benefit from the time value of money. Thus, the general partners at the private investment funds then have what some perceive to be unfair tax advantage. The limited partners, if they are taxable, are then at a comparative tax disadvantage because they cannot receive a deduction for the carried interest when it is granted. If they are not taxable, as many limited partners aren't i.e. pension funds, then the government loses tax revenue. The tax deferral argument is particularly more relevant when it comes to funds that are not persistent in their performance. When a fund is consistent in its increasing returns, as venture capital funds tend to be, the deferred taxes grow greater over time. When a fund has inconsistent returns, the smaller deferred taxes from bad years offset the higher deferred taxes from successful years[http:<ref name = "fleischer" //victorfleischer.com/wp-content/uploads/2009/12/Two-and-Twenty.pdf]>. *The second and more emphasized point is that carried interest is subject to the capital gains tax rate mentioned before. Opponents of such treatment consider carried interest to be a performance-based compensation, much like a bonus, and believe it should be taxed at the ordinary income rate. In their argument, the opponents frequently compare general partners' roles to those of corporate executives and mutual fund managers who are subject to the ordinary income rate[https://www.<ref name = "cbo.gov/budget-options/2013" /44804]>.
Those in favor of the current treatment of carried interest argue that the general partner's role is more analogous to that of an entrepreneur. Just as an entrepreneur sells his or her business and is taxed at the capital gains rate, so too should the general manager be taxed on his or her realized gains at the capital gains rate. Further, it is claimed that a higher tax rate would reduce incentive for general partners to take risks. This lack of incentive would then discourage innovation and efficiency in markets. Although, it is not clear whether there is evidence for these claims or if the risks general partners take on provide a benefit to the economy as a whole[https://www.<ref name = "cbo.gov/budget-options/2013" /44804]>.
==References==
<ref name="fleischer">[http://victorfleischer.com/wp-content/uploads/2009/12/Two-and-Twenty.pdf] 'Two and Twenty: Taxing Partnership Profits in Private Equity Funds',''New York University Law Review'', (New York City: April 2008) </ref>
<ref name = "cbo">[https://www.cbo.gov/budget-options/2013/44804] 'Tax Carried Interest as Ordinary Income', ''Congressional Budget Office'', (Washington D.C.: November 2013) </ref>
http://www.streetofwalls.com/articles/private-equity/learn-the-basics/how-private-equity-works/
http://poseidon01.ssrn.com/delivery.php?ID=827006111117101076120127100094005111103049014093061025126075006126024094004067006067098030052002015017013092031071074023126005052019045093022024030088100111030086041039086122093005127112071088088083006093097112086026017003096006001105007085116120006&EXT=pdf
<ref name = "pearl">[http://thehill.com/blogs/congress-blog/economy-budget/257083-what-the-carried-interest-tax-loophole-reveals-about-our ] M. Pearl, 'What the carried interest tax loophole reveals about our corrupt political system', ''The Hill'', (Washington D.C.: October, 2015) </ref>
<ref name = "opensecrets>[http://www.opensecrets.org/industries/totals.php?cycle=All&ind=F] ''Center for Responsive Politics''</ref>
