Taxing the kings of private equity like the rest of us
Cheers to the New York Times, the Financial Times, the Economist, Charlie Rangel, Robert Rubin, Alan Blinder, Paul Krugman, Warren Buffet (I think it is implied here), Bill Gross, Greg Mankiw (extra-credit, given Mankiw’s party identity), Andrew Ross Sorkin and Joe Schocken (of Broadmark Capital) for defending the concept that all income should be taxed as, well, income.
Jeers to Chuck Schumer, wavering congressional Democrats, Hank Paulson and the Private Equity Council.
If, as some now suggest, private equity funds will try to offset higher taxes on their principals by raising their already high fees at a time when the market is no longer as favorable to the basic private equity strategy of gearing up, they have every right to try. If Qatar, Abu Dhabi and I would assume the Saudi royal family are willing to pay up, that would at least help the US balance of payments. On the other hand, some pension funds might conclude that they can do better — after fees — by shifting out of private equity into other assets (Felix has more).
Some private equity managers may be worth every penny. But some may have just been in the right place at the right time: the last few years have rewarded anyone who borrowed money to buy illiquid assets.
I see no reason why those who toil in the trenches of the financial sector – including, say independent researchers with rather variable income – should be taxed at a significantly higher rate than those sitting in corner office. I also hope that US politics doesn’t become a contest between a party that defends tax breaks for parts of the oil and gas industry (populated at least in part by cultural conservatives) and a party that defends tax breaks for a small fraction of the financial sector (populated at least in part by cultural liberals), especially if the equilibrium outcome is both get their tax breaks.
The record clearly shows that Senator Schummer is currently filling his campaign coffers with funds from the boys and girls who benefit if their tax rates are not increased. Sadly Schummer has years to go in the Senate and will be “on the take” with campaign contributions. We should not expect his position to be any other than that of a bought politician. He can correct this if he chooses and refuses to take contributions. Maybe there will be a snow storm on Wall Street in August too, but don’t count on it.
Beginning under former Treasury Secretary Robert Rubin and Federal Reserve Chairman Alan Greenspan, the narrow economic interests of Wall Street financial institutions prevailed over other industrial and productive sectors of the US Economy. On Wall Street, the “Greenspan-Rubin put” referred to federal government intervention in the marketplace to eliminate “moral hazard” for Hedge Fund speculators and Wall Street investment banks. By socializing risk to the US taxpayers, the Federal Reserve’s bailout of Long Term Capital and other highly leveraged Hedge Funds has increased systemic risk to the entire US Economy; the dispersion of risk has generated additional leveraged speculation in capital markets. Over the past two decades, capital has been massively misallocated across the US Economy into non-productive speculation in financial assets. The $11 trillion Credit Bubble in real estate and $750 trillion in financial derivatives are products of the Wall Street-Treasury complex, extreme financial leverage coupled with weak financial regulatory oversight. With real estate prices collapsing, trillions of dollars of home equity and credit will soon be wiped out, imploding the US Economy into a severe recession.
One reason to tax capital gains (and dividends) differently than employment income or interest income is that the former has already been taxed at the corporate level while the latter is tax deductible.
I would argue it never makes sense for a company to issue dividends. They may as well just buy back the stock instead, thus inflating the stock’s value. That way, the returns it can give it’s shareholders can be tax deferred…
DC– how does your comment relate to the debate over taxing carried interest? I am not of greenspan’s position on carried interest, but i am quite sure that rubin favors a far more progressive tax system (with higher rates than those in place now at the top) than greenspan.
I should though have added hank paulson to the list of folks opposed to taxing hedge funds and private equity kingpins like the rest of us.
Whether fees are “worth it” has no place in a discussion of tax policy. I’m surprised seeing you, as an economist, even bringing it up.
The crux of the issue, IMHO, is the characterization of fees as either income or capgains. While there’s an argument to be made that the carried interest is in lieu of income and should be taxed as such, it seems to me that the issue could be resolved by requiring fees be explicitly paid when earned, and which could reinvested in whole or in part as a carried interest. The fee itself (which would also include any discount given to fair market value of subsequent carried interest) would be taxed as income, and the gains on the investment (carried interest), if any, would be taxed as capgains.
estragon — i like the idea of taxing the fees (including performance fees) as income when earned, and then if it is reinvested in the fund and taxed like all other investment (as cap gains). the FT’s proposal to defer taxation until the “income” is realized and then to tax it all (including the capital gains on the initial tax free fee that was reinvested in the fund) as income also would work — that is how stock options are taxed. the result is an incentive to exercise the option quickly, pay the tax and then incur capital gains on the now owned asset.
I like the idea of governments being forced to demonstrate their capacities to better allocate revenues they already receive:
“…Despite historic highs in transportation spending, the political muscle of lawmakers, rather than dire need, has typically driven where much of the money goes. That has often meant construction of new, politically popular roads and transit projects rather than the mundane work of maintaining the worn-out ones… it may often be less the amount allocated for transportation than how it is doled out that leads to eroding highways…” http://www.nytimes.com/2007/08/07/us/07highway.html?_r=1&ref=business&oref=slogin
Deferral is the equivalent of an interest-free loan by the extended to the deferrors by “the people”, granting them a further additional subsidy on the potential future lost use of income earned therefrom. One could (of course) mark, both deferrals and carried-interests to-marketeach year, as I believe Australia does) each year forcing you to pay upon unrealized gains/losses.
Cassandra — my assumption on “deferral” is that the gap between the capital gains tax rate and the income tax rate currently provides a very strong incentive to take advantage of the “subsidy” (to some) or “appropriate lower” (to others) rate on capital gains by realizing the income quickly and then getting the benefit of the cap. gain tax rate. i suspect the differential between the income tax rate and the cap gains tax rate is bigger than the additional subsidy from the deferal — but that is just a guess. you certainly raise a conceptually good point.
previous guest = bsetser, apologies.