July 31, 2007
Zeal for Raising
By BRODY MULLINS and SARAH LUECK
July 31, 2007; Page A1
WASHINGTON -- Some prominent Democrats are beginning to rethink proposed tax increases on hedge-fund and private-equity managers' earnings, after an aggressive pushback by industry lobbyists and arguments that the impact could extend far beyond Wall Street.
The shift may make it tougher for any legislation to win passage, or strengthen a push to find a compromise. Democrats hold only a slim majority on Capitol Hill and defections of just a handful could delay or defeat such a measure if Republicans unite to oppose it. Until now, opposition was largely limited to Republicans.
"When you first hear about it, it seems like, 'Yes, this looks like an appealing way to generate a lot of revenue,' but when you study it more it seems like there are some serious unintended consequences," said Rep. Brian Baird of Washington, a member of a coalition of centrist Democrats who often play a deciding role on business and tax bills.
Among other things, lawmakers say they worry a tax boost could take a bite out of public pensions' investment returns, adversely affect financial-sector profits and employment or, more broadly, disrupt investment incentives.
It remains to be seen, however, how any individual Democrat might vote on the issue, especially if it is combined with another, more popular Democratic priority. One such vehicle might be legislation to reduce the hit of the alternative minimum tax, which was designed to prevent the richest Americans from dodging their taxes but will ensnare growing numbers of middle-class taxpayers. That combination would fit with Democrats' broader push for tax equity.
But the new concerns being voiced come amid a concerted lobbying effort by private-equity firms and hedge funds aimed at heading off the move. Many Democratic lawmakers are also major beneficiaries of campaign donations from private-equity and hedge-fund executives, and may be wary of shutting off the spigot.
Employees at the 11 members of the industry trade group the Private Equity Council gave 69% of their $3.4 million in campaign donations to Democratic candidates last year, up from 51% of $2.7 million in 2000, according to the nonpartisan Center for Responsive Politics. Campaign-finance data for large hedge funds show a similar pattern of giving.
A concern raised by some Democrats is whether a new tax increase on fund managers will hurt returns for public-employee retirement plans. Joe Dear, executive director of Washington state's largest government-employee pension plan, predicted that any tax increase would be passed along to investors in the form of higher management fees. If so, pension funds and other investors would see a decrease in their returns.
"The private-equity general partners are the cleverest people in the world. Does anyone really think that they will end up paying the tax bill that is aimed at them?" he said.
Other pension funds with large private-equity investments, such as the California Public Employee Retirement System, have yet to take a position on the legislation.
In an interview last week, Senate Finance Committee Chairman Max Baucus said the effect on pension-fund returns is an issue his committee will explore, but that it has been overstated. The Montana Democrat's committee will hold a hearing on carried interest today, and four of the panel's 11 Democrats represent states that have among the largest pension-fund investments in private-equity funds.
Private-equity funds buy companies using large amounts of borrowed money, hoping to quickly resell the acquired firms at a profit. Hedge funds are loosely regulated funds for institutional investors and rich individuals.
At issue is a proposal to increase taxes on a portion of profits fund managers receive -- known as "carried interest" -- to personal income-tax rates as high as 35%, from the current 15% capital-gains rate that now applies. The debate centers on whether the law properly regards carried interest as investment income, or should be changed to treat some or all of these profits as compensation for services. While carried interest is common to a variety of business partnerships, specific arrangements vary, even within the private-equity and hedge-fund industries.
Mr. Baucus and the senior Republican on his committee, Iowa Sen. Charles Grassley, haven't yet proposed formal legislation. But possibly building to that, they have questioned whether wealthy private-equity and hedge-fund managers are avoiding their fair share of taxes.
In recent weeks, some prominent advocates of raising taxes on carried interest have emerged -- including some economic experts who worked for Republican administrations. Gregory Mankiw, formerly chairman of President Bush's Council of Economic Advisers, recently said on his blog, "Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such." His comment was among several circulated to lawmakers last week by Rep. Sander Levin of Michigan, who is lead sponsor of the House Democrats' bill.
A group of House Democrats including Ways and Means Committee Chairman Charles Rangel of New York introduced legislation in June to boost taxes on carried interest to 35% for private-equity and hedge-fund managers, as well as certain venture-capital and real-estate deals. He offered no estimate as to how much money such an increase would bring.
Seeking to ring a populist tone, all of the leading Democratic presidential candidates have said they would support the legislation. The major Republican presidential aspirants, like most of their party's congressional contingent, oppose the idea.
In the beginning, Democrats on Capitol Hill were mostly supportive of the tax proposal or silent about it. Now that they have studied the issue more closely, a growing number say they worry about its unintended effects. Washington Sen. Maria Cantwell fears it could reduce returns for her state's public-employee pension plan, which has reaped benefits from private-equity investments. Sen. Ron Wyden of Oregon says he would prefer to focus on more-comprehensive tax reform.
Lawmakers who represent the New York City area, such as Rep. Joe Crowley, say any new taxes on fund managers could hurt Wall Street by driving private-equity and hedge-fund activity offshore. They also are concerned a tax increase could reduce the flow of business for other financial-services firms if the number of deals and stock transactions were to dry up.
Other Democrats simply say Congress shouldn't rush into any changes. "It's an important issue...but there's no reason it has to be done in a certain time period," said Democratic Rep. Xavier Becerra of California. Rep. Kendrick Meek, a Florida Democrat who serves with Mr. Becerra on Ways and Means, says he was briefed for the first time on the issue last week by experts from Congress's nonpartisan research arm.
Neither Ms. Cantwell, Mr. Crowley nor Mr. Becerra have received any money from executives of major industry firms so far this election cycle.
New York Sen. Charles Schumer, the top fund-raiser for Senate Democrats -- and a perennial favorite of Wall Street donors -- was among the first in his party to question the legislation. He says Congress shouldn't single out hedge-fund and private-equity managers. Any legislation, he says, should be expanded to include managers of other investment partnerships, such as real estate, oil and gas, timber and agriculture investment vehicles. Such a move, though, would likely boost opposition to it.
Lawmakers' emerging concerns may open the door to compromise. Some Democrats have discussed a plan to raise the tax on carried interest above 15%, but lower than the 35% proposed in the House bill, an idea floated by some in the private-equity industry.
"I think there's some interest on the part of some individuals who are in the private-equity community in trying to find some middle ground on this issue," said Rep. Artur Davis, an Alabama Democrat.
At a hearing in the Senate Finance Committee today, executives from private-equity firm the Carlyle Group and hedge fund Oaktree Capital Management will make the case that their activity benefits the U.S. economy. Lobbyists for the industry have told lawmakers that increasing taxes on managers may decrease returns for public-employee pension plans and university endowments, both of which are increasingly reliant on the healthy returns they receive from investments in private-equity funds.
Mr. Rangel says he has heard the most concern about changing the policy from within his home state. But he said that wouldn't stop him from pursuing changes.
"How could anyone ask me, a born and raised New Yorker, to give New York preferential treatment at the expense of the tax system?" Mr. Rangel said. "My heart might say, 'I wish I could help,' but there's nothing to indicate that making an even playing field would jeopardize New York."
Write to Brody Mullins at email@example.com and Sarah Lueck at firstname.lastname@example.org
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