Carried Interest Repeal Could Stifle Startup Investments, Warns NVCA
On Thursday, former President Donald Trump reignited the debate over the carried interest tax break, urging Republican lawmakers to put an end to this long-standing tax incentive. The proposal has sparked concerns within the venture capital (VC) industry, particularly from the National Venture Capital Association (NVCA), which argues that eliminating the tax break could significantly impact investment in startups and emerging technologies.
Understanding Carried Interest and Its Role in VC Investments
Carried interest is a form of compensation that private equity and venture capital fund managers receive as a share of profits from their investments. Under the current tax structure, these earnings are treated as long-term capital gains rather than ordinary income, which results in a lower tax rate. Proponents of this tax structure argue that it incentivizes investors to take risks on innovative, high-growth startups that might otherwise struggle to secure funding.
Bobby Franklin, President and CEO of the NVCA, emphasized the importance of carried interest in fostering innovation. In a statement, he noted, “Carried interest encourages smart, high-risk investments in innovative high-growth startups.” The VC industry relies heavily on such incentives to channel funds into emerging sectors like artificial intelligence (AI), cryptocurrency, life sciences, and national defense.
Trump’s Previous Stance on Carried Interest
The debate over carried interest is not new. During his 2016 presidential campaign, Trump vowed to close the carried interest loophole, arguing that it disproportionately benefits wealthy investors. However, when the Tax Cuts and Jobs Act (TCJA) was enacted in 2017, the carried interest provision remained largely intact, with one notable change: the holding period required for assets to qualify for capital gains tax treatment was extended from one year to three years.
For the venture capital industry, this modification was seen as a reasonable compromise. Since VC firms typically hold onto investments for longer than three years before exiting, the impact of the change was minimal. As Franklin pointed out, “The 2017 Trump tax legislation kept venture investment flowing to emerging technologies like AI, crypto, life sciences, and national defense. A change now will disrupt that progress and disproportionately harm small investors, especially in middle America.”
Potential Consequences of Repealing Carried Interest Tax Breaks
If the tax break is repealed, earnings from carried interest would be taxed as ordinary income, significantly increasing the tax burden on VC fund managers. The NVCA and other industry advocates argue that this could have several negative consequences:
- Reduced Incentives for High-Risk Investments: Many startups, especially in cutting-edge industries, rely on VC funding to develop groundbreaking technologies. A higher tax rate on carried interest could discourage investors from taking risks on early-stage companies.
- Potential Capital Flight: Venture capitalists may shift their investments to more tax-friendly jurisdictions or industries, leading to reduced funding for innovation-driven sectors in the U.S.
- Disproportionate Impact on Small Investors: While the majority of venture capital funding is concentrated in Silicon Valley and New York, emerging startup hubs in the Midwest and other regions could face difficulties attracting investment without the tax incentive.
Is Change on the Horizon?
Despite the NVCA’s concerns, the push to eliminate the carried interest tax break continues to gain traction in political circles. Critics argue that the loophole primarily benefits wealthy financiers and should be closed to ensure a fairer tax system. However, industry stakeholders warn that such a move could inadvertently stifle the very innovation and economic growth that policymakers aim to promote.
As the debate unfolds, the future of carried interest remains uncertain. Whether lawmakers choose to eliminate the tax break entirely or seek a middle-ground solution will have profound implications for the venture capital ecosystem and the broader startup landscape. Investors, entrepreneurs, and policymakers alike will be watching closely as this issue continues to develop.
References
- National Venture Capital Association (NVCA): https://nvca.org
- Tax Policy Center: https://www.taxpolicycenter.org
- Internal Revenue Service (IRS) – Carried Interest Taxation: https://www.irs.gov
- Congressional Budget Office (CBO) – Analysis on Carried Interest: https://www.cbo.gov