Most private equity firms are paid on the 2-and-20 model: a 2 percent annual fixed fee on all the money it invests and 20 percent of all profits above a certain threshold. The United States taxes money made from investments—so-called capital gains—at a lower level than money made through ordinary labor, whether at a factory or in an office. The distinction is ambiguous and unfair, but even more so, private equity firms have convinced the IRS that their 20 percent income should be taxed at the lower capital gains rate than at the higher ordinary income rate.109 This means that many private equity executives often pay a lower effective tax rate than the retail employees, secretaries, and factory workers they employ. But the industry as a whole has fought hard, and successfully, to defend this imbalance.

Private equity firms use so-called management fee waivers to give more of their income this preferential treatment. Here, private equity firms waive some or all of their 2 percent management fee (which is taxed at a higher rate) in exchange for a priority claim on the profits earned (which is taxed at a lower rate). Through a variety of tactics, however, the firms virtually guarantee that they will make this money back.110 Some of the biggest firms—KKR, Apollo, and TPG Capital—used these fee-waiver provisions.111 Many of these schemes might violate the spirit, if not the letter, of the law. The IRS investigated fee waivers during the Obama administration but very little came of it. An audit of Thoma Bravo for use of the tactic, for instance, took four years and resulted in no actual adjustments to the company’s tax returns. In 2015, the Obama administration proposed regulations to bar the most aggressive forms of fee waivers. But nothing came of that either: the regulations were never finalized. Ultimately, both of President Obama’s treasury secretaries—Tim Geithner and Jack Lew—left the government to work for private equity firms.