Planet Money: The carried interest tax loophole survives another challenge

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The last days of debate over the Inflation Reduction Act, as it was called, centered on what's called the carried interest loophole. Stay awake now. This matters. An attempt to close the loophole was removed during negotiations to collect enough Senate votes. Kenny Malone from NPR's Planet Money podcast tells us this is part of a much bigger story about a tax code that is riddled with similar exceptions.

KENNY MALONE, BYLINE: The carried interest loophole is how some very rich people in the private equity, venture capital, hedge fund world pay lower taxes today. But for some backstory, we head to the 1950s.

(SOUNDBITE OF TV SHOW, "THE ABBOTT AND COSTELLO SHOW")

BUD ABBOTT: Got to get rid of that $3,000, or we'll have to pay income tax on it.

MALONE: Comedians Abbott and Costello have been doing a surprising number of taxation routines.

(SOUNDBITE OF TV SHOW, "THE ABBOTT AND COSTELLO SHOW")

LOU COSTELLO: I wonder how I can get rid of this money.

ABBOTT: Wait a minute. I've got it. We'll give $1,000 apiece to the first three people we meet.

MALONE: That is some low-key tax-dodgery right there, which might have been topical because the U.S. had been in decades of expensive wars. Taxes had been going up and up. And by 1951, the top marginal income tax rate was 91%. Steven Bank is a tax law professor at UCLA and says it's not like politicians wanted this old wartime rate, but cutting it would have looked like a break for the rich.

STEVEN BANK: That was, like, kind of embarrassing. So Eisenhower didn't want to - nobody wanted to lower the top rate. But they all recognized that the top rate was outrageous. So the way to deal with that without lowering the top rate was to provide a lot of exemptions, to overlook a lot of things.

MALONE: The '50s sound like tax-break Oprah. You get a tax break. You get a tax break. And at one point, the tax code had a break for, like, film executives who left their jobs after 20 years and held profit shares for 12 years. And everybody was like, wait - this only applies to L.B. Mayer, the second M in MGM. Rich people were calling in the lobbyists, plus calling up tax lawyers to find all kinds of workarounds.

BANK: Large portion of the tax industry was devoted to conversion.

MALONE: Conversion - meaning, can you call all this money that I'm getting this other thing? And problem solved.

BANK: Exactly.

MALONE: Classic trick - you convert personal income into capital gains, for example, which is taxed at a much lower rate. So the '50s are all exemptions and deferrals and conversions, carving up the tax code into Swiss cheese. In 1954, the tax code was due for a big restructuring. But instead of our politicians just clamping down on the dodges and lowering the personal income tax rate, Congress and the IRS seemed to decide the fairest thing to do was tell everyone about these rich people tricks.

BANK: If 1954 enshrined anything, it's the entire code was replete with examples of people lobbying for specific provisions that would allow them to avoid the high marginal rates. It's what everybody was doing at the time.

MALONE: And just one of many little carveouts in the 1954 code was, basically, the carried interest tax break, a now-infamous tax break but also this vestige of the 1950s tax break bonanza that helped build the messy tax code that we all know and love today.

Kenny Malone, NPR News. Transcript provided by NPR, Copyright NPR.