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The world’s biggest private equity firms have avoided income taxes on more than $1 trillion in incentive fees since 2000 by structuring payments in a way that exposed them to much lower fees, according to new research from the University of Oxford.
Ludovic Phalippou, a professor at Oxford’s Said School of Business, found that fund groups engaged in private investment strategies such as buyouts, venture capital, infrastructure and distressed debt have earned more than $1 trillion in so-called carried interest payments since the turn of 2008 . century.
Phalippou’s calculation comes at a time when such performance bonuses have drawn political scrutiny in the US and Europe for years, and he faces a wave of renewed calls to close what prominent politicians characterize as a “loophole”.
The savings are in the hundreds of billions of dollars at current tax rates. Fees are charged at long-term capital gains rates that are substantially lower than income tax rates. In publicly traded companies, up to half of the fees are paid out to shareholders in the form of dividends.
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Britain’s Labor Party is pledging to close the loophole in a push led by shadow chancellor Rachel Reeves, who previously branded the tax treatment “absurd” and said in 2021 she hoped to raise taxes on the private equity sector by £440m a year.
Earlier this year, Reeves vowed to push through a plan to charge a top income tax rate of 45pc on profits private equity firms make on successful deals, amid mounting pressure from industry lobbyists. Currently, “carried interest” payments are taxed at a 28 percent capital gains tax rate.
In the US, recent presidents including Barack Obama, Joe Biden and even Donald Trump have promised to end special tax treatment, but eventually backed down due to industry pressure. In the UK, critics of Labour’s plan say that rising tax rates will drive successful investment groups out of London, just as the need to attract foreign capital is paramount.
In an interview with the Financial Times, Phalippou said his research was intended to show the vast wealth created by high-fee private funds for a select group of influential billionaires mostly living in the US. It also aims to reveal to governments the potential tax revenue they could generate if such fees were treated as income and not capital gains.
“All governments talk about taxing the interest earned. So my role is to provide the best estimate of the number,” said Phalippou, whose report is titled “Private Equity Fund Managers’ Trillion Bonus.”
“It shows you the upper limit of what you could collect if all the countries in the world coordinated on taxing this bank,” he said. “Once you understand how much money we’re talking about, you’ll understand why private equity is the biggest donor to politicians and universities,” he added.
Phalippou calculates that Blackstone Group, the world’s largest private equity investor, earned $33.6 billion in carried interest, the most of any investment firm. The windfall made their top executives, Stephen Schwarzman and Jonathan Gray, multibillionaires, and the duo are among the most influential political donors to Republican and Democratic lawmakers.
A representative for Blackstone declined to comment.
Schwarzman recently announced his support for Trump’s election and will be fundraising among his peers for the former president’s re-election campaign.
Phalippou said his work was also intended to provide new insights into 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, which he says is comparable to the approximate long-term returns of U.S. stocks.
“It’s hard for me to look at these numbers and be amazed,” he said. “Does this seem extraordinary to me? $1 trillion seems quite extraordinary. The return number not so much,” Phalippou said. “It’s good, but it’s nothing to write home about.”
Drew Maloney, president and chief executive officer of the American Investment Council, which represents the private equity industry, said: “This study reports that private equity investors have generated $5 billion in returns for retirees. This shows alignment between investors and managers.”