What’s the Difference Between a Waitress and a Private Equity Partner? (Their Tax Rate)

If the waitress works in an upscale restaurant and earns a decent living, there is a good chance that she is paying a higher tax rate than a private equity partner. The reason is that private equity (PE) partners get most of their pay in the form of “carried interest.” This is money that is paid to them as a share of the returns on the money they manage. Since private equity partners are rich and powerful, their carried interest payments are taxed at the capital gains tax rate of 20 percent, instead of the 37 percent top tax rate that people earning millions a year would be paying.

The ostensible rationale for allowing PE partners to pay a lower tax rate on their carried interest is that these payments involve risk. If the funds don’t meet some threshold rate of return, then they don’t earn any money.

The New York Times had a major piece on tax avoidance and evasion by private equity partners, which gave this rationale. However, the piece neglected to point out that millions of workers take this sort of risk, since they get paid, in large part, on commission. This list would include realtors, car salespeople, and waiters and waitresses. In all of these cases, the money earned as a commission is taxed as normal income. It is only PE partners, or hedge fund and venture capital partners, that get to pay a lower tax rate.

The tax savings for PE partners are substantial. For a PE partner earning $10 million a year, the savings between the current 37 percent top marginal rate and the 20 percent capital gains rate would be roughly $1.7 million a year. That comes to more than 1,100 food stamp person years.

This first appeared on Dean Baker’s Beat the Press blog.