The Labour Party and Carried Interest – why does it matter?

Carried interest. What does it mean? Why does it matter? If you know the answers to those questions, feel free to skip a couple of paragraphs. But for everyone else, carried interest sounds so opaque that it couldn’t possibly be of any interest (excuse the pun). So why does the Labour Party keep going on about it?

Whenever you hear Sir Keir Starmer or Rachel Reeves talking about the economy, chances are they’ll mention carried interest. Not usually by name – that would be too direct for politicians – but in more generic language. Official Labour Party documents talk about “closing tax loopholes for private equity fund managers.” Reeves claims that “private equity bosses say that their income is capital gains…we would close that loophole.”

These are all references to carried interest. But what is carried interest?

It’s more straightforward than it sounds.

After the return of capital to investors, private equity fund managers typically receive 20% of a fund’s overall profits as payment for sponsoring and managing that fund. So far so simple. The controversy arises because private equity managers only pay capital gains tax (a rate up to 28%) not income tax (a rate of up to 45%) on carried interest. The majority of countries where PE is well-developed have a favourable tax regime for carried interest.

Many will argue there is good reason for this. The profits of private equity funds come from the sale of assets. It is reasonable that they attract capital gains tax. Others argue that a fund’s profits basically amount to income for private equity managers and should be taxed as such. Labour is clear about which side of the argument it supports. Reeves has claimed that taxing carried interest as capital gains is “absurd” and gives “tax breaks for fund managers averaging £170,000…as they asset strip some of our most valued businesses.”

That doesn’t sound like the basis for a great relationship between Labour and the private equity sector. But the Labour Party is not alone in calling for a change. A similar debate has been raging in the United States, where carried interest is also taxed as capital gains. Initial drafts of the Inflation Reduction Act would have required fund managers to hold an asset for five years before receiving the advantageous tax rate. The Senate Democrats argued this would raise $14 billion over 10 years – a relatively modest revenue-raiser in the context of the US economy. But according to Senate Majority Leader Chuck Schumer, the Act would also ensure “the wealthiest corporations and individuals pay a fairer share in taxes”. A political rather than economic motive.

Back in the UK, the Labour Party is trying desperately to appear pro-business. In a speech to the CBI in November, Starmer said that Labour Party was “not just a pro-business party but a party that is proud of being pro-business.” So why the attack on private equity? As in the United States, the money raised from changing the tax rules on carried interest would bring in relatively little – around £440 million a year. Which means, as in the United States, the motive can’t be primarily economic. It must be political.

This is because Labour is eager to appear pro-business in order to gain economic credibility, but it isn’t afraid of criticising business when it’s politically expedient to do so. And those sectors of which the public may have a less positive impression – such as private equity – are first in the firing line. By pitting wealthy financiers, whom Labour argues are avoiding tax, against ordinary working people who pay their fair share, Labour aims to present itself as the party of economic justice. Redistributing wealth from a small number of financial elites to support the greater mass of ordinary people.

In other words, the Labour Party is looking to get the keys to Downing Street and will do whatever it can to appeal to voters (as all political parties aspiring to government should do). It believes that increasing tax on carried interest and bashing financiers will achieve this. Which means that carried interest, as niche and as dull as the term may sound, is actually rather interesting, particularly as a microcosm of Labour’s economic approach in the round.