General partners in an investment fund, like a hedge fund, venture capital fund, or private equity fund, generally receive compensation as (1) management fees usually equal to a percentage of the fund’s assets and (2) carried interest, or a share in the fund’s profits from those assets.  

Although management fees are taxed as ordinary income (at rates as high as 37 percent), carried interest is generally taxed at a lower capital gains tax rate (as high as 23.8 percent). 

Supporters of the lower rate of tax on carried interest argue that a higher tax rate would discourage investment and harm economic growth. Critics counter that the provision primarily benefits fund managers without significantly affecting overall investment levels.  

TPC's Donald Marron has argued that to tax carried interest efficiently and fairly, private equity fund managers should pay ordinary income tax rates on their carried interest, and investors who compensate those managers should be able to deduct the compensation as a business expense.  

How much more revenue could the federal government collect if carried interest were taxed differently? The Congressional Budget Office estimates that treating carried interest as ordinary income could raise $13 billion over ten years.  

Recent legislative efforts have sought to restrict the tax advantage of carried interest, including extending the required holding period for qualifying investments. Many private equity and hedge funds continue to benefit from carried interest rules, ensuring persistent debate over its fairness and fiscal impact. 

Learn more about carried interest and how it’s taxed in our Briefing Book.