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The world’s largest private capital firms have avoided income taxes on more than $1tn in incentive fees since 2000 by structuring the payments in a way that subjected them to a much lower levy, according to new research from Oxford university.
Ludovic Phalippou, a professor at Oxford’s Said School of Business, found fund groups dedicated to private investment strategies such as buyout firms, venture capital, infrastructure and distressed debt have earned more than $1tn in so-called carried interest pay since the turn of the century.
Phalippou’s calculation comes as such performance fees have for years drawn political scrutiny in the US and Europe, and face a wave of renewed calls to close what prominent politicians characterise as a “loophole”.
The savings amount to hundreds of billions of dollars at current tax rates. The fees are charged at long-term capital gains rates that are substantially lower than income tax rates. For publicly traded firms, as much as half of the fees are paid to shareholders in the form of dividends.
The UK’s Labour party is pledging to close the loophole in a push led by shadow chancellor Rachel Reeves, who has previously called the tax treatment “absurd” and in 2021 said she hoped to increase taxes on the private equity sector by £440mn annually.
Earlier this year, Reeves vowed to push ahead with a plan to charge the top 45p rate of income tax on profits that private equity firms earn on successful deals amid growing pushback from industry lobbyists. At present, “carried interest” payments are taxed at the 28 per cent rate of capital gains tax.
In the US, recent presidents including Barack Obama, Joe Biden and even Donald Trump vowed to end the special tax treatment but ultimately retreated amid industry pressure. In the UK, critics of Labour’s plan say increasing tax rates will cause successful investment groups to leave London just as the need to attract foreign capital is paramount.
Phalippou said in an interview with the Financial Times that his research was meant to show the enormous wealth created by high-fee private funds for a select group of influential billionaires mostly living in the US. It is also aimed at revealing to governments the potential tax revenue they could generate were such fees to be treated as income and not capital gains.
“All the governments are talking about taxing carried interests. So my role is to provide the best estimate of the number,” said Phalippou, whose report is titled “The Trillion Dollar Bonus of Private Capital Fund Managers”.
“It shows you the upper bound of what you could collect if all of the countries in the world co-ordinated to tax that pot,” he said. “Once you understand how much money we are talking about, you can understand why private equity is the largest donor to politicians and universities,” he added.
Phalippou calculates that Blackstone Group, the world’s largest private equity investor, has earned $33.6bn in carried interest, the most of any single investment firm. The windfall has made its top executives Stephen Schwarzman and Jonathan Gray into multibillionaires, and the duo are among the most influential political donors to Republican and Democratic lawmakers, respectively.
A Blackstone representative declined to comment.
Schwarzman recently announced his support for the election of Trump and will fundraise among his peers for the former president’s re-election campaign.
Phalippou said his work was also meant to provide new information about whether private investment strategies are worth their cost. His report shows that the median private equity fund earns about 1.6-times investors’ money over four or five years, something he said was comparable to the approximate long-term returns of US stocks.
“It is hard for me to look at these numbers and be amazed,” he said. “To me, does it look extraordinary? The $1tn seems quite extraordinary. The return number not so much,” Phalippou said. “It is good but it is not something to write home about.”
Drew Maloney, president and chief executive of the American Investment Council, which represents the private equity industry, said: “This study reports that private equity investors generated $5tn in returns for retirees. This demonstrates the alignment between investors and managers.”