How the Carried Interest Loophole Survives Every Tax Reform and Saves Private Equity Billions Annually

Washington’s constant promises to eliminate the carried interest loophole have an almost theatrical quality. Every few years, a candidate takes the stage, accusing hedge fund managers of “getting away with murder.” In 2016, Donald Trump said just that. Prior to him, Barack Obama made a similar statement. Nevertheless, in 2026, the loophole is still in place and continues to provide billions of tax savings to a select few fund managers who, by most accounts, are least in need of them.

The politics are more complicated than the mechanics. In exchange for managing other people’s funds, a private equity manager receives a 2% yearly fee and retains 20% of the profits once the investments are profitable. If the fund retains the asset for a minimum of three years, that 20%—the “carry”—is taxed as a long-term capital gain rather than regular income. As a result, the top rate on what is essentially a paycheck is 20%. In addition to payroll taxes that the fund manager is not responsible for, a salaried employee making a small portion of that pays a marginal rate of up to 37%.

This has been brought up by critics for almost twenty years. Closing the loophole would raise about $12 billion over a ten-year period, according to estimates from the Congressional Budget Office. This amount is not huge in federal terms, but it is also not nothing. Since the financial crisis, private equity’s assets under management have nearly tripled to $8.2 trillion, according to McKinsey’s 2023 estimate. The tax treatment of its profits has expanded along with the industry, which now affects everything from suburban dental offices to hospital chains.

The number of reform initiatives that have quietly failed is startling. Despite Trump’s repeated campaign promises and his economic adviser Gary Cohn’s insistence on CNBC, weeks before the bill was dropped, that the administration was “committed” to ending carried interest, House Republicans in 2017 drafted a comprehensive tax overhaul that essentially left it untouched. The final compromise, which increased the holding period from a year to three, was the legislative equivalent of a shrug. Investments are already held by the majority of private equity funds for longer than that.

Then, in 2022, Senate Democrats were on the verge of success once more, but Senator Kyrsten Sinema intervened at the last minute and eliminated the clause from the eventual Inflation Reduction Act. A quiet but successful lobbying effort was documented at the time, including that of billionaire David Rubenstein, co-founder of the Carlyle Group, whose charitable profile inexplicably continued to rise in tandem with his industry’s tax benefits. It’s difficult to ignore the pattern. Because those who stand to gain from it are also the ones who can afford to ensure that it continues, the loophole continues to exist.

Of course, there is a defense, and it isn’t wholly irrational. Fund managers contend that they assume actual economic risk, that capital gains treatment promotes long-term investment, and that this type of incentive structure is essential to the innovation economy in the United States. At least partially, some economists concur. When you contrast the tax bill of a private equity partner with that of a married couple making, say, $100,000, the argument tends to fall apart because the married couple pays a higher marginal rate on each dollar over the standard threshold.

It’s still unclear if anything will change under the current Congress. The political will is present, albeit sporadically, but the reform mechanisms continue to break down. As you watch this unfold over several administrations, you begin to suspect that the loophole is no longer truly a loophole. It’s a feature. Even though no one in the public is willing to admit it, the tax code appears to be doing precisely what it was intended to do in this particular area.