John O'Farrell, a partner at venture capital firm Andreessen Horowitz, says he believes carried interest is essentially compensation for doing work, managing investments and generating returns; therefore, it should be treated as ordinary income.

“I’ve argued for more than 15 years that carried interest is a fee for service, and thus should be taxed as ordinary income. Many of you vociferously disagree (some sincerely, some selfishly). I agree,” the executive wrote on X.

A new report from The Budget Lab at Yale argues that the U.S. has been significantly underestimating how much tax revenue could be generated by closing the carried interest "loophole," which allows many private equity and venture capital managers to pay lower capital gains tax rates on compensation that critics say should be taxed as ordinary income.

IRS data and new academic research have now made it possible to better estimate the size of carried interest income. 

"The results indicate that previous estimates did, in fact, substantially undercount how much revenue could be gained from reforming carried interest taxation," the report stated.

New Estimates Increase Projected Tax Revenue

The report re-estimates revenue from a carried interest proposal included in the Biden Administration's 2025 budget, noting that it would raise about $28.1 billion over 10 years, nearly triple older estimates of $10.7 billion.

In comparison, a recent reform proposal made by Sens. Ron Wyden, Sheldon Whitehouse and Angus King to introduce legislation to close the carried interest loophole raises $47.5 billion over 10 years. However, using the new estimates, the revenue now totals $87.7 billion over the same 10 year period.

While a broader proposal taxing all carried interest as ordinary income could raise more than $100 billion over a decade, with revenues continuing to grow substantially in later decades.

The report explains that carried interest is typically the roughly 20% share of investment profits paid to fund managers, in addition to an annual 2% management fee. Because those profits are often taxed as long-term capital gains instead of wages, fund managers can face lower tax rates than many salaried workers.

Better IRS Data Is Reshaping The Debate

Researchers say the newer estimates are possible because expanded electronic IRS filings now allow analysts to better trace partnership income and distinguish profits earned from labor versus invested capital. 

A 2025 study by economist Michael Love found that estimated carried interest income grew from roughly $35 billion in 2011 to $89 billion by 2020.

"This is not a failure of methodology so much as a reflection of the underlying data gap, which could be addressed with additional information reporting," the report stated.

Requiring general partners or managing members to separately identify carried interest on Schedule K-1 tax forms would give policymakers and researchers a clearer way to measure how much carried interest income exists. That would improve the accuracy of revenue estimates for tax reforms, make it easier to evaluate policy changes, and could also boost tax compliance and government revenue, the report concluded.

Photo: Shutterstock

Photo: Shutterstock