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What Would Happen If We Closed Mitt Romney's Tax Loophole?

Under increasing pressure to divulge his income tax returns, Mitt Romney announced today that he’s “probably” taxed at a fifteen percent rate (he seems more certain of the amount of jobs Bain created). The number is significant. If Romney were a typical rich guy, he’d pay 35%—the top marginal rateon most of his yearly income. But since he’s a private equity guy who still gets paychecks from Bain Capital, he’s taxed at 15%, the capital gains rate that the Bush tax cuts instituted. We’d be accused of inciting class warfare if we suggested private equity’s “carried-interest loophole” was somehow unfair. Instead, let’s just imagine the US has a long-term deficit problem and needs to raise additional revenue. How much money would the government bring in if it eliminated the loophole and taxed private equity managers at 35 percent?

The question is a complicated one in part because we can’t project how much private equity firms will invest, or what profits they’ll make from their investments (partners get a cut of each). Assuming they invest $200 billion in a given year, as UPenn Law School professor Michael Knoll did in a 2008 study, the amount of extra revenue brought in would total anywhere from $2-3 billion a year. (To contextualize, the Office of Management and Budget estimates that 2012 tax receipts will total $2.6 trillion.) Though Kroll’s figures are compatible with a 2007 report by the Joint Committee on Taxation ($2.4 billion per year) he included a caveat the JCT didn’t. By shrewdly changing the nature of their partnerships, private equity firms may be able to blunt the blow of the tax reform. For example, if the firm's investors make loans to partners rather than direct capital contributions, the firm’s return on those loans would be taxed again at 15 percent, not 35 percent. Or as Knoll puts it: “It is thus possible that there would be little or no net increase in tax collections from taxing carried interests as ordinary income.” What did you expect?