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Democrats in Congress, seeking new sources of revenue after passing President Barack Obama's $940 billion health-care reform measure, may double tax rates on executives at private-equity firms.
The U.S. Senate has taken up a House proposal to levy a new tax on executives who make long-term investments, including venture capitalists, managers of real- estate partnerships, hedge-fund and private-equity managers, Bloomberg News reported.
The proposal, expected to raise $24.6 billion over a decade, eliminates a tax provision which allows money managers at privately held partnerships to treat most of the revenue they bring in as capital gains.
Managers at typical private-equity firms and hedge funds get paid a fee equal to about 2% of assets they manage, plus 20% of the fund's profits. They pay regular income tax on the 2%. But on their share of the profits, which is called "carried interest," they usually pay taxes only at the rate for long-term capital gains — usually 15%. That saves private-equity managers billions of dollars a year.
The difference in tax rates means the managers pay taxes at a much lower rate than an average worker. That is true even though they put up hardly any of the fund's actual capital, most of which comes from outside investors.
The House proposal would tax carried interest at ordinary income-tax rates. The top ordinary rate is 35% and is scheduled to increase to 39.6% in 2011.
The Senate is under pressure from the Obama administration, which has twice sought higher taxes on carried interest in budget requests.
Treasury Secretary Timothy F. Geithner in February told the Senate Budget Committee the administration was in favor of the tax increase and would also encourage the United Kingdom to adopt a similar policy.
"Even though the measure doesn't produce a lot of revenue, it's good economic policy," Geithner said at the time.
Investment managers shouldn't be paying less in taxes than firefighters, he said.
Even some heavyweights on Wall Street have characterized the preferential tax treatment given to the private equity managers as basically unfair.
"If you believe in taxing people who earn income on their occupation, I think you should tax people on carried interest," Warren Buffett said at a recent congressional hearing on the subject, according to The New Yorker.
As part of a jobs bill, the House in December passed a measure closing the loophole for the third time in three years. Until now, the Senate has refused to even consider the bill.
But it appears that hunger for new-found sources of funding for jobs bills, unemployment extensions and healthcare reform will force the Senate to at least consider the proposal.
Senate Finance Committee Chairman Max Baucus, D-MT, said in December that he wanted to address the issue in the context of a broader overhaul of the tax system. But an aide close to Baucus told Bloomberg Tuesday the chairman is reconsidering the proposal because of the need for revenue.
Opponents of reform suggest that it will have a "chilling effect" on investment at a time when the economy needs all the help it can get.
Buyout firms are getting back to business-as-usual after the global credit crisis put a damper on mergers and acquisitions activity. About $14.2 billion worth of private-equity deals have been announced in 2010, compared with $3.36 billion in the same period a year earlier, according to data compiled by Bloomberg.
But others say doing away with the tax break for fund managers won't change the incentives for the investors who actually put up the money for these partnerships, because their capital will still be taxed at the capital gains rate.
For its part, the private-equity industry has spent millions of dollars lobbying legislators to drop the proposed reforms. Private-equity and other investment partnerships have spent $5.7 million on the 2010 congressional elections with 69% of that going to Democrats, according to the Center for Responsive Politics, a Washington-based group that tracks political giving.
"Our position on carried interest remains as it has been for three years: It is investment income and it should be taxed as a capital gain," Robert Stewart, a spokesman for the Private Equity Council, a Washington trade group representing investment firms, including Blackstone Group LP (NYSE: BX) told Bloomberg.
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