POLICY BRIEF: Why Carried Interest is Vital to America's Economic Growth

As Congress discusses the extension of the Tax Cuts and Jobs Act (TCJA), one important policy that has come up for debate is the tax treatment of carried interest. Carried interest is a form of compensation granted to investment fund managers based on the fund's performance. For decades, carried interest has been treated as capital gains rather than ordinary income, a distinction that has incentivized long-term investment in real estate, energy, manufacturing, and other critical industries with high capital requirements for growth.

Opponents of the current tax treatment argue that it gives investment managers preferential tax advantages not available to other professions. However, economists and policymakers warn that raising the tax rate on carried interest would have devastating effects on job creation, capital formation, and economic growth. With the American economy at a pivotal juncture, preservation of the existing carried interest structure is essential to ensuring continued investment in small businesses, innovation, and U.S. global competitiveness.

"This tax treatment has been vital for venture capital, private equity, and real estate professionals, encouraging investment in American businesses and the subsequent benefits of job creation," said Rep. Warren Davidson (R-OH).

A Policy That Works: Learning from the 2017 Tax Cuts and Jobs Act

Since the passage of the TCJA in 2017, private equity firms have invested more than $5 trillion into the U.S. economy, with 85% of those investments supporting small businesses. These investments have helped finance startups, revitalize struggling industries, and fuel economic expansion.

The success of the TCJA demonstrates the importance of maintaining a tax structure that encourages capital investment. The law struck a balance that allowed carried interest to continue benefiting the economy while still encouraging long-term investment. An analysis by the Senate Finance Committee highlighted that any significant change to the carried interest deduction would increase taxes on private investment, raise costs for businesses, eliminate jobs, decrease returns for average Americans, and discourage long-term investment.

Drew Maloney, CEO of the American Investment Council, emphasized the importance of keeping this sound policy in place. "We're optimistic that we'll see a continuation of the 2017 bill," he said. "We think it's very important for the economy to incentivize investment. That's what we need right now—more investment from businesses of all shapes and sizes across this economy."

A Threat to Small Businesses and Job Creators

If carried interest were taxed as ordinary income rather than as capital gains, private equity firms would be disincentivized from investing in small businesses or entrepreneurial ventures, reducing overall capital deployment. Steve Forbes, editor-in-chief of Forbes, warned about the risks of such a move in a column. "Hiking the tax on carried interest capital gains would discourage entrepreneurs who invest their time, energy, and expertise in businesses like these—and America would be worse off because of it," he wrote.

Maintaining the current provision is valuable to thousands of small and family-owned businesses across the country. Private equity has played a crucial role in job creation, helping companies expand, innovate, and compete on a global scale. Sen. Tommy Tuberville (R-AL) has pointed to the tax treatment of carried interest as a crucial component of private equity's ability to grow the economy and boost the retirement savings of working Americans.

Harming the Real Estate Sector

Carried interest is particularly vital to the commercial real estate (CRE) industry, where investors take on significant risk when developing projects like shopping centers, housing developments, and office spaces. The International Council of Shopping Centers (ICSC) recently published a report warning that nearly half of its surveyed members would not have pursued key business deals without the benefits of carried interest.

The capital gains treatment of carried interest in CRE, also known as the "promote," recognizes the unique risks developers take. If Congress increases taxes on carried interest, many of these projects may no longer be financially viable, leading to fewer developments, fewer jobs, and slowed economic growth.

Global Competitiveness at Stake

Raising the tax rate on carried interest would also undermine U.S. competitiveness in the global economy. Current proposals to hike the tax on carried interest would increase the effective rate from 23.8% to 40.8%, pushing the U.S. behind countries like China, Germany, and the UK. Raymond J. Keating of the Small Business & Entrepreneurship Council also warned that increasing tax rates would make investing in the U.S. less appealing, especially when major international competitors offer more favorable tax policies.

"Taxes cannot be raised without negative consequences," Keating explained. "Increasing taxes on investment will negatively impact business startups and growth, inflicting broad damage on incomes, jobs, entrepreneurship, competitiveness, and economic growth."

The Bigger Picture: Investment and Innovation

A Blow to AI and Technological Advancements

In the midst of the AI revolution, maintaining a tax code that encourages investment in cutting-edge technology is critical. Palantir cofounder Joe Lonsdale recently predicted that raising the rate on carried interest would result in a capital freeze, preventing investors from reallocating funds into the next generation of transformative projects—at the very moment that AI could revolutionize the global economy.

Technological advancements require patient, long-term capital investments. Taxing carried interest at a higher rate would stifle these investments, slowing down breakthroughs in not only artificial intelligence, but also clean energy and medical research.

A Call to Action: Keep Carried Interest Intact

Maintaining the current tax treatment of carried interest is essential to ensuring long-term economic prosperity. Proposed changes to carried interest could raise taxes by an estimated $6.5 billion over the next decade, discouraging investment and reducing economic growth.

The stakes are clear:

Job creation and small business growth are at risk.
America’s real estate sector could face serious setbacks.
The U.S. could lose its competitive edge in global markets.
Investment in AI and emerging industries could slow dramatically.

Instead of imposing new tax burdens, Congress should focus on making the pro-growth tax cuts from the 2017 Tax Cuts and Jobs Act permanent and promoting policies that attract capital to American businesses. By protecting carried interest, lawmakers can preserve a tax policy that has fueled economic expansion, innovation, and job creation for decades.