Investment Pros Still Hoping For Better Terms On Carry Tax

From the WallStreetJournal.com:

Proposed new Senate legislation on carried interest taxation offers slightly more favorable terms to the private equity and venture capital industries than a bill already passed by the House of Representatives, but investment professionals continue to hope for better.

An amendment introduced by Sen. Max Baucus (D-Montana) suggests that beginning in 2013, 65% of carried interest would be taxed at normal income rates, while 35% would be taxed as capital gains. The House proposal set a 75%-25% split.

Unlike the House version, the Senate version also offers incentives for fund managers who hold investments for the long term, reducing the percentage of carry taxed as ordinary income to 55% for investments owned for at least seven years.

Both versions of the bill would phase in the higher tax rate, taxing 50% of carried interest as ordinary income in 2011 and 2012.

Carried interest has long been taxed at capital gains rates, currently around 15%. The normal income tax rate, in contrast, is currently around 35%.

The private equity industry has been lobbying heavily against the higher tax rates, and some senators have expressed concern the changes could stymie investment.

Congress's Carried Interest Tax Folly

From the Wall Street Journal:

Nero fiddled while Rome burned, but at least he didn't strike the match. Members of Congress are doing Nero one better. In the middle of the second global financial crisis in two years, Congress is preparing to dramatically raise a key tax rate on long-term investment. This is sure to discourage capital investment, increase the cost of money to start and grow businesses, and depress real-estate and stock prices, all at the worst possible time.

Last week, Senate Finance Committee Chairman Max Baucus (D., Mont.) and House Ways and Means Chairman Sander Levin (D., Mich.) released joint legislation that would among other measures significantly raise the tax on "carried interest." Now the tax rate on these long-term capital gains earned by the general (managing) partners of investment partnerships is 15%. The new law would raise the rate to as high as 38.5% (three-fourths of the gain would be taxed at ordinary income tax rates and one-fourth at capital gains rates, both of which will be increasing as well).

Tax rates matter. And what matters about them is what activities get taxed, not who gets taxed. When you increase the tax rate on an activity, you get less of it. The only question is how much less of it you will get.

Congress should be asking one question: "Is long-term investment something we really want less of, especially now?" Unfortunately, in today's political climate, tax policy discussions focus almost exclusively upon whom, not what, gets taxed. This means singling out specific groups of people—bankers, Wall Street, "the rich," the owners and executives of insurance, oil and drug companies—to punish for our economic difficulties. This may be politically popular but will have bad consequences for the economy.

Putting a Bull’s-Eye on a Tax Loophole

From The New York Times:

Tucked away on Page 122 of President Obama’s budget is a proposal that has the fast money crowd up in arms: “Tax carried interest as ordinary income.”

It sounds like something only a certified public accountant would care about. But in fact, the Obama administration wants to close one of the biggest tax loopholes on Wall Street — one nobody seemed to notice in good times, when everyone was minting money.

As things stand now, private equity firms and hedge funds get a much better deal from the taxman than the rest of us. They are taxed at a mere 15 percent — the capital gains rate — on most of their income, instead of the higher regular income tax rate. For the past two years, they have scrambled to keep it that way. And with the economy swooning, the industry was hoping lawmakers might just forget about this little tax giveaway.

How do they justify it? Private equity types and other investors argue that they’re in the business of investing, so they should be taxed like investors who make money in the public markets. The “carried interest” in question — the bulk of these firms’ profits — refers to the 20 percent cut of profits they take when they sell, or exit, investments.

This tax deal always struck a lot of people as a little too sweet. One study commissioned last year by a Congressional committee estimated that executives would save $30 billion in taxes over the next 10 years if the rules did not change. (Of course, that was before the financial crisis began.) Buyout firms and their executives have some skin in the game, but mostly they invest using other people’s money, like pension funds. So their 20 percent cut of profits is closer to a commission than a true capital gain.

Warren E. Buffett has pointed out that this tax treatment has enabled ultrawealthy executives to pay a lower tax rate “than our receptionists do or our cleaning ladies.” (I know, I know: many people believe Mr. Buffett has managed to avoid taxes too, in part by giving away his fortune to charity, but that’s beside the point.)

And Robert E. Rubin, the former Treasury secretary who was a senior adviser at Citigroup, has also been a sharp critic.

“You can characterize it as a performance fee, you can characterize it as a carried interest, you can characterize it any way you want,” Mr. Rubin said in a controversial comment in 2007. “I think at the core there is a very good argument to be made for treating this as ordinary income.”