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→The Debate
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, generating a benefit for a lack of persistence in performance <ref name = "fleischer" />.
*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 thus believe it that carried interest 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 , two parties who are subject to the ordinary income rate<ref name = "cbo" />.
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<ref name = "cbo" />.
