Why Connecticut Should Get Onboard with Closing the Carried Interest Loophole

This time last year, Gov. Dannel Malloy of Connecticut advised deferring to Trump on the elimination of the egregious carried interest loophole. A year later, it appears the Democratic governor is going to have to take a firm stance on how he will either defend or upend the loophole that benefits hedge fund managers as if they themselves were the investors.

The carried interest loophole is a source of derision for everyone but those who utilize it because it is a clear example of misinterpreting longstanding practices to enrich the already wealthy. The loophole gets its name from the centuries-old practice of ship captains receiving 20% of the profits from the safe delivery of cargo carried onboard.

Today, fund managers pay taxes at a rate of 20%, as if they are investors. This special tax rate is intended to serve as an incentive for continued investment in our economy. Given hedge fund managers do not risk their own money, but instead that of their clients, why should they benefit from this incentive when the janitors and lawyers who work for hedge fund companies do not get the same special treatment?

In Governor Malloy’s case, the answer is clear and his motives are less than admirable. Connecticut has the second-largest hedge fund industry in the country. With over $151 billion under management in the Constitution State, it is no wonder Malloy has threaded the needle on this issue. Although he has opted not to run for reelection in 2018, Gov. Malloy has let economic inequality in the state flourish rather than ostracizing the donor class.

With failing infrastructure throughout the state, it is remarkable that the governor would defer to the president, who has a history of not following through, to keep his word on such an important policy decision. Unsurprisingly, the passage of the GOP’s huge tax overhaul last month did not include any language removing the carried interest loophole.

Given this new development, Governor Malloy’s position on the loophole needs to be revisited. In the coming year, CT and three other states (PA, NJ, NY, MA) will be voting on a multi-state compact to pass a 19% surcharge on “investment management service fees” to reclaim the percent in taxes that is lost through hedge fund managers avoiding the marginal tax rate. This compact would only become law if passed in all of the partnering states, and would limit the hedge fund industry’s ability to play state’s tax favorability against one another, in particular Connecticut versus New Jersey and New York.

Gov. Cuomo of New York’s budget has included the “Fairness Tax” to close the carried interest loophole. With Connecticut facing a $1.6 billion deficit this fiscal year, Gov. Malloy should do the same. Estimates state that recapturing tax income lost through hedge fund manager’s exploitation of the capital gains rate would bring in approximately $520 million.

Malloy’s options are clear: He can either get in front of the impending end of the carried interest loophole and argue for a hedge fund manager surcharge that the state desperately needs, or he can remain silent while corporate interests control his policy preferences until the end of his term.

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