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July, 20th 2007

The battle continues over hiking taxes on private equity gurus

– Liz Mair

So, when I was in New York earlier this week, I was pleased to see reported in the paper at which I write, the New York Sun, that Harry Reid was essentially planning to park consideration of a big tax hike that Max Baucus (D-MT) and Charles Grassley (R-IA), as well as most of the Democratic party, want to push through.

To remind readers, this tax hike is one that would see private equity partnerships paying an extra 20% in tax. That's a big, bad tax hike, which is terrible in itself, but the real reason that this proposal is bad is not just because it hikes taxes. It's also because it totally ignores basic principles that apply to business and tax law, in general. At present, private equity gurus get taxed at 15% when they extract money from a private equity fund by way of carried interest (also known as performance fees) because:

a) money paid out in respect of carried interest corresponds to capital, not income-- i.e., the gurus don't get paid the same amount regardless of what happens to the assets under their control, as would be the case if the carried interest were really income; they get paid solely if the assets under their control increase in value, i.e., if there is a capital gain-- so carried interest should be taxed at the capital gains tax rate, not the income tax rate, as a matter of logic; and

b) no matter how much Democrats and Mr. Grassley may want to pretend that a partnership is a corporation, and should be taxed at the 35% rate in respect of capital gains (this is of course assuming the failure of their argument that carried interest corresponds to income, a patently false characterization) just like a corporation would, legally, partnerships are not distinct entities from their members. In other words, if we're talking about capital gains tax, as long as the partnership is comprised of Fred, Joe and Harry, as opposed to IBM, Microsoft and Wal-Mart, the tax rate applicable to individuals, not companies, is what should apply.

Baucus, Grassley, and tax-hiking Democrats want to ignore all of this and pursue the "soak the rich" proposal which, as I've stipulated before, would have terrible consequences not just for the economy, but for workers who are employed by businesses that are routinely the subject of bailouts by the private equity industry, and which no other investor class would touch (e.g., GM).

To get back to the point, what was written in the Sun earlier this week about Harry Reid wanting to park consideration of this proposal until next year was great news for those of us who oppose this on principle. But, it hasn't proven to be the end of the debate for now, of course. Yesterday, Ben Bernanke, while trying to avoid commenting on the proposal, did say that if implemented, it could drive private equity overseas (no good thing). And, for her part, Hillary Clinton has weighed in, too saying "It offends our values as a nation when an investment manager making $50 million can pay a lower tax rate on her earned income than a teacher making $50,000 pays on her income."

Honestly, for someone with a law degree from Yale, you'd think that Hillary would know better and might have an inkling of the difference between salary (i.e., earned income) and capital gains. Sadly, I guess back in the day, a JD from Yale wasn't worth as much as everyone thought. Since John Edwards and Barack Obama have been on about hiking taxes on carried interest for some time now, maybe we can assume the same about a JD from Harvard and a JD from UNC-- evidently, they are also not worth much when it comes to the knowledge they deliver in respect of legal terminology applicable to tax law, either.

Either that or being in the Senate has numbed Hillary, Barack and Edwards' brain cells to the point that none of them can tell the difference between different types of income and capital flows anymore. Or they just want to grab as much as they can of everyone's money, and run with it.

If the Democrats, including Hillary, Obama and Edwards, and Mr. Grassley, too, were concerned about a lack of equity when it comes to who pays what rates of tax, they would go ahead and pursue a flat tax-- and not one pitched at the 35% rate (which I'm guessing Hillary might be OK with, based on her comments)-- maybe one at the 20% rate, or the 15% rate. But that's never going to happen, so in the meantime, I guess we get to contend with them driving a debate that is about different rules for different people, based on arbitrary and inconsistent criteria, which make no sense and will deliver nothing of any substantial benefit (apart from a sense of "getting even with the rich guys") to those for whom Hillary, Obama and Edwards purport to speak.

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