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Analysis: Carried interest thrust again into tax debate

By Kim Dixon

WASHINGTON (Reuters) - A big tax break that benefits U.S. private equity and venture capital executives is under threat again, and this time the chances of preserving it may have dimmed.

President Barack Obama said at a news conference on Tuesday that he will pursue a short list of tax loophole closures to try and avert looming budget cuts. Obma's press secretary singled out the tax break known as "carried interest."

"That should be closed," White House spokesman Jay Carney told reporters after the president spoke.

Obama on Sunday had mentioned carried interest in a CBS television interview in which he called for reducing the budget deficit by raising more tax revenue by closing tax breaks.

Past attempts by some senior Democrats to roll back the provision have failed amid heavy lobbying by the private equity industry and other investment managers. The tax break has been defended by lawmakers from both parties, but this time advocates of repeal say they may have the upper hand.

Carried interest is an industry term that describes a large portion of the investment gains realized by private equity managers, as well as executives at some venture capital, real estate and hedge funds.

The tax break allows these financiers - many of whom are among the wealthiest people in the country - to treat such income as capital gains, making it subject to a tax rate of only 20 percent, instead of the nearly 40 percent top rate on ordinary income paid by the highest earners.

Carried interest became a campaign issue last year when it emerged that Republican presidential hopeful Mitt Romney had paid an effective tax rate of about 15 percent in the past, thanks in part to the favored tax treatment. Romney, one of the wealthiest Americans to ever run for the White House, was a co-founder of private equity giant Bain Capital.

Sander Levin, the top Democrat on the tax-writing House of Representatives Ways and Means committee, has been pushing for years to end the tax break, and plans to soon introduce legislation again. He said the tide is turning after Obama's campaign.

"Elections matter. When issues are raised and the people speak, it matters," Levin said in an interview.

Closing the tax break could raise close to $20 billion over 10 years, according to congressional budget estimates.

Defenders of the provision say it is proper because the risks taken by those who claim it are comparable to the risks of stock market investing. So carried interest gains, they say, should be taxed like investment income, not wage income.

Opponents say carried interest is more akin to ordinary income, and that financiers should have to pay the same top income tax rate that other workers do.

TAX BREAK WAS CAMPAIGN ISSUE

Republicans for years have been steadfast in their defense of the tax break, although Romney was careful during the campaign not to take a clear position on it.

Senator Orrin Hatch, the top Republican on the Senate Finance Committee, which has tax oversight, told Reuters on Monday: "I've always supported carried interest, but I'm going to certainly look at every suggestion that the president makes."

Hatch on Tuesday said in a statement that Obama's plans were "tax hike gimmicks" that will do little to tame the U.S. debt.

Still, a former top Republican Finance Committee aide said there is sympathy among Republicans for the argument that the carried interest provision represents an unfair tax loophole.

"If there is a real bill moving forward, there is some real risk" that the tax break could be curbed, the former aide said.

"Republicans are not going to throw it overboard at the beginning, but at the end of the day, I think it is something that could go, because it might be better than the alternatives," he said.

Mark Heesen, president of the National Venture Capital Association, whose members benefit from the carried interest provision, said: "The question will be on the Republican side, if they will accept any type of tax increase."

DEMOCRATS CAN BE SKITTISH

Republicans have not been alone in defending the carried interest provision. Some Democratic senators have done so.

"Whenever it was raised in a caucus, members get up and say something needs to be done," a former Democratic Senate aide said. "Then slowly but surely when it comes to voting on it, members get a lot more skittish."

Current Senate Budget Committee Chairwoman Patty Murray was among those in 2010 arguing for a carve-out for venture capital, which many say should be treated separately to encourage start-ups, such as those in Seattle, in Murray's home state of Washington.

"What I was concerned about is the venture folks," Democratic Senator Bob Casey, who also had concerns, said. "I just don't know what it will look like," he said when asked if he would back Obama's proposal.

At the same time, Democratic Senator Charles Schumer of New York fought hard against such an approach. Private equity firms are heavily concentrated in Manhattan.

Greg Valliere, chief political strategist at investor research firm Potomac Research Group in Washington, D.C., said it was unclear if Democrats would remain a hurdle.

"But if Republicans could raise taxes on the wealthy, surely the majority of Democrats can end carried interest -- especially if it's part of a deal to avoid sequester," Valliere said, referring to the next big budget battle.

On March 1, postponed spending cuts known as the sequester are to start to kick in. Lawmakers and the White House are scrambling to find ways to avoid this, possibly through a mix of more limited budget cuts and tax measures, though some on Capitol Hill expect the sequester will take effect.

(Reporting by Kim Dixon; Editing by Kevin Drawbaugh, Martin Howell, Andrew Hay and Leslie Adler)

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