Three years ago, chancellor Rachel Reeves vowed to end the tax loophole exploited by a handful of private equity executives as they ‘asset strip some of our most valued businesses’. As Labour’s manifesto succinctly explained, ‘Private equity is the only industry where performance-related pay is treated as capital gains. Labour will close this loophole.’

Reeves was right and her description jusrified. But her budget left the loophole unbunged. Instead, she merely raised the charge on ‘carried interest’, as these earnings are called, from 28 to 32 per cent. From 2026, ‘carry’, as it is more usually known, will be brought under the income tax umbrella – but under ‘bespoke rules to reflect [the industry’s] unique characteristics.’ Mayfair breathed a sigh of relief.

Labour’s original plans aimed at the UK’s 3,000 buyout chiefs, who claimed carry of £6.4bn in the two years 2022-23. Taxing it as income would have brought in £500m a year. Under the budget proposals, that shrinks to a mere £140m – one-tenth of the £1.3-£1.5bn savings from cutting the winter fuel allowance. From which it’s hard not to conclude that, just as some companies are too big to fail, some of the rich have become too powerful to tax – never mind how the sums are earned, or how much we need the investments they are supposed to bring to the economy.

Start with the earnings. Carried interest originated in 16th century Italy, where merchants and shipowners levied a charge of 20 per cent against the profits of the cargos they ‘carried’ to pay for transport and the risks of a long-distance sea voyage. It was later used in the oil and gas industry to compensate the financial interest for the risk that the wells of the drillers it was funding refused to gush. Both of these involved real risk: ships could be wrecked or seized by pirates, oil wells might be dry. The only thing private equity shares with either of these is the time it takes for the profits to materialise, measured in years.

 As to risk, for equity privateers it is negligible. For one thing, they already command a hefty annual ‘management fee’ of 2 per cent of assets under management, sometimes more. And the amount of personal capital put up by PE partners is often derisory, or even nil. The only reason for Reeves not taxing carry as income is FOMO – fear of missing out on their taxes or investment.

But if some high earners did depart, how much would it matter? PE’s motive force was always personal greed – ‘I could see it was a gold mine’, exulted Blackstone’s Stephen Schwartzman, now a multibillionaire many times over, when he looked at KKR’s infamous ‘barbarians at the gate’ Nabisco buyout of 1988. But in the early days it could also be argued, and was, that what PE claimed to do – generate superior returns for institutional investors by geeing up managers at indifferently performing companies to do better – contributed to conomic efficiency.  If the price was that some of the targets went bust with their resources redistributed to more efficient actors – hey, that’s just capitalism’s creative destruction for you.

More than $12tr-worth of worldwide PE deals later, that argument looks a lot thinner. For a start, those ‘superior returns’ are disputed. They can’t be proved, because private equity is, as it says on the tin, private (another word would be ‘opaque’, which doesn’t quite have the same ring). That in fact turns out to be its major competitive advantage against investing in public markets, since PE gets to choose the benchmarks it measures its performance against (among many other ways of gaming the figures). While there are still plenty of institutional investors eager to buy, some reputable studies suggest that on current form they would do just as well investing in public stockmarkets – which, as one academic puts it, ‘(to put it mildly) is not what PE investors are paying for.’ For another expert, given the high costs of the initial buyout deal (buyouts are an expensive business), the exorbitant ‘2 & 20’ fees and charges over the lifetime of the fund and ‘the many layers of potential agency conflicts’ involved, it would be  outperformance that was surprising, not the lack of it.

The economic efficiency claim is no stronger. Most of the inviting (ie inefficient) targets have long ago been picked off and ‘improved’. Instead, the massive surge in buyout volumes in the decade after the 2008 crash increasingly consisted of short-term trades in which targets were bought and quickly flipped to another buyout firm to cash in on rising stockmarket valuations – transactions of no benefit except to the fund and requiring little management skill. Even PE insiders admit that those glory days, when zero interest rates meant that anyone with a line of credit could turn a tortoise into a hare almost overnight, are gone, probably for ever. Others privately fret that with IPO exits drying up and investors clamouring for payment, PE houses are concocting ever more complex forms of debt refinancing, with the risk that a default could trigger a private-markets meltdown. A totally unregulated industry, opaque valuations, no settled definitions, conflicts of interest, mounting debt – what could possibly go wrong?

The truth is that private equity is shareholder-value capitalism on steroids, and for that reason alone Labour should be subjecting it to the beadiest scrutiny. PE is a one-trick pony, with debt as its only weapon, at levels that crowd out any other management concern. Interestingly, it is now beginning to admit as much: with debt becoming a two-edged sword, PE chiefs are suddenly wondering how real companies back on planet earth that actually make and sell things work and even prosper. Some are even contemplating shaving off some of the carry for the workforce of their bought-out firms.

But this is all obfuscation – ESG-washing, if you like. For the one area where PE really does generate outsize returns is one that it would rather not boast about, since it is the carry that richly benefits not clients but its own top managers. Analysis by Said Business School’s Ludovic Phalippou shows that between 2006 and 2015, while PE investors were getting returns similar to those yielded by the stockmarket, the funds’ managers were pocketing $230bn of lightly taxed carry. Most of the loot went to ‘a relatively few individuals, mostly founders of large PE firms’ – a finding reflected in Phalippou’s calculation that between 2005 and 2020 the number of PE multibillionaires rose from three to 22. The wealthiest of all, Blackstone’s Schwartzman, was worth $37.4bn in 2021, a pot that is growing by at least $1bn a year. No market can be called efficient that generates such grossly distorted rewards, let alone for so long.

Blackstone’s buyout of Hilton Hotels for $6.8bn in 2007 eventually resulted in a profit of $14bn, $2.6bn of which was paid out as carry for the fund’s top managers. It has been described glowingly in the press as the best such deal ever. Yes, says Phalippou: but for whom?

Over to you, Rachel.