'Carried interest' no cash cow, says study

Raising taxes on private equity managers probably won’t generate a whole lot of money, according to a new study. At the moment, managers typically collect 20% of the profits they make, which are taxed at a 15% capital gains rate. But if the rate goes up to the 35% income tax rate, the government will collect, at most, $3.2 billion in revenue, according to a paper by Michael Knoll, a law professor at the University of Pennsylvania in Philadelphia. Approximately $200 billion is invested each year in private-equity funds, and between $12 billion to $17 billion in carried interest is granted. If that cash were taxed at the ordinary income rate of 35%, it would generate between $2 billion and $3.2 billion in additional revenue, Mr. Knoll said. If taxes on “carried interest,” the cut from profits that managers receive, were to increase, the funds would adjust their structure to dodge the tax reforms, Mr. Knoll said in his study. For example, the private equity funds can have their portfolio companies pay the carry, instead of having the limited partners foot the bill, he said. This way, the portfolio companies become eligible for a deduction and the money saved will be equivalent to the additional tax the general partners paid.