GOP combines with a handful of corrupt Democrats to stand tall in defense of the right of uber-rich private equity managers to pay a lower tax rate than you or I. It makes one proud to be an American, doesn't it?
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The Billionaires Lobby
09 Oct 2007 09:10 am
Comments (31)
It's worth naming some names here. Chuck Schumer, whom I admire in many respects, is one of the strongest supporters of the hedge fund managers in this tax fight, which is too bad.
Chuck Schumer, whom I admire in many respects, is one of the strongest supporters of the hedge fund managers in this tax fight, which is too bad.
I was under the impression Schumer had reversed himself on this in recent weeks, although I'm too lazy to google it to verify.
Schumer didn't reverse himself. I believe he said he supported a proposal that is, in effect, a poison pill - it wouldn't just affect private equity firms, but just about all partnerships, which would inevitably stall the measure because then you'd have everybody from the oil-and-gas industry to the real estate industry trying to stop the bill.
Hey-- rich or poor, it's nice to have money.
Look on the bright side -- disastrous climate change might threaten these people's private islands, allowing us to do the good deed of paying for their disaster relief.
Capital has always been an obscene bawd, but they used to dress her up in a pretty frock to try and disguise her true nature. Now rich and poor alike revel in her depravities.
It's weird and disgusting. As someone who had, for a couple of years, low-mid-six figure incomes during the dotcom era from options, and who filled out 1040As and paid six-figure tax bills that were based upon pure income and much of it in the highest bracket...the idea that folks can make their living doing things and then pretend it's not work income makes me sick. There's one rule for most working Americans, and then there's a set of special tax exempt rules for our Capitalist Overclass.
Carried interest is a capital gain. The billionaires pay the exact same capital gains tax as you do, they just have a lot more of it. To claim they pay a lower tax rate is untrue and disingenuous.
The decision is the the correct decision. When tax policy is established by liberal demagogues who are seeking to solve to an outcome (ie, we should take money away from guys who eat expensive stone crabs), the result is almost always wrong. This is how the AMT mess was created; if this group has its way, this is how the wheels will come off one of the drivers of the American economy.
Sadly, you're mis-reporting the story. Today's news is about timing, not the longer-term outcome.
"Carried interest is a capital gain."
Intelligent folks disagree on this, but this is certainly true:
"When tax policy is established by liberal demagogues who are seeking to solve to an outcome (ie, we should take money away from guys who eat expensive stone crabs), the result is almost always wrong."
In this case, raising taxes on private equity managers will further erode New York City's status as a financial capital and drive more private equity funds (and their tax revenues and jobs) overseas.
Yes, Fred, but then we will have achieved something closer to an equality of outcomes. We may all be poorer, but we will be more equally poor.
I'm curious whether the assembled group would like to tax entrepreneurs who start companies at ordinary income tax rates? Presumably you know that the vast majority of Bill Gates' forture will be taxed at lower rates than our salaries.
This issue doesn't have to be an ideological death-struggle. Yes, it's arguable whether carried interest is "income for work" or not. The PE industry probably could have avoided this whole thing if they hadn't overreached and started playing games to make their fixed management fee taxable at the cap gains rate also. But how about just raising the cap gains rate a couple of points? Raise more revenue, leave current structures and incentives basically in place and avoid screwing with the PE industry.
But NOOOO, we can't do that of course. Won't play politically. Better to pick on the super-rich only (never mind that only the very top of the income ladder pays significant cap gains tax anyway).
Publius,
The aborted Dem targeting of private equity was actually an anomaly: Dems usually leave billionaires (who, as you suggest, pay far more in capital gains taxes than income taxes) unscathed in favor of targeting what I call the "working rich": folks with low-mid six-figure incomes from salaries
Yes, but this time the billionaires got themselves in the newspaper and a few Senators decided that it would be a good idea to re-invest US fiscal policy to 'fix' the problem of one rich guy eating stone crabs -- pay no mind to the implications to economic growth, capital formation, the competitiveness of the US, etc, etc, etc
Are the stone crabs a reference to Blackstone's Stephen A. Schwarzman? He does tend to be a little unabashed in flaunting his wealth.
BTW, have you invested in this space at all? I bought some Fortress Investment Group (FIG) at 18.10 this summer. Fortress's business includes hedge funds and blank-check IPO "castles" as well as private equity.
I'm curious whether the assembled group would like to tax entrepreneurs who start companies at ordinary income tax rates? Presumably you know that the vast majority of Bill Gates' forture will be taxed at lower rates than our salaries.
This is an extremely important point that is completely missed in this debate. It is SUPER EASY to replicate the "carried interest" model (which avails itself of a partnership) in a corporation. You can issue super-cheap incentive stock, the recipient can elect to include the nominal value of the stock in income at ordinary rates, and then all the upside from there is capital gains. The current carried income proposals don't speak to this phenomenon at all; they gladly leave it in place. Aiming at "carried interest" without seeing how the basic concept proliferates throughout the tax law will only create more and weirder distortions. This is usually bad policy.
This leaves only two options: (1) abolish differential rates between OI and CG, or (2) stop pretending like the issuance of a "carried interest" is worth nothing, and tax its value upon grant like you would an option.
I'll mention as an aside that the availability of the incentive stock alternative lays waste to claims that the proposed change in tax law would raise billions of dollars. That's a joke.
DJ,
I agree the PE industry would find a work-around, but if you make the PE fund a corporation don't you generate an extra level of tax? Your proposal will work for the fund managers but not the investors.
As for your other options, I repeat, just raise the cap gains rate some, don't eliminate the differential. Your option (2) is not really practical - it is not possible (or fair) to value carried interest in advance. And options are not generally taxable at the time of grant in any event unless they are issued at below current market value. Most of the value of option grants generally lays in the potential upside anyway, just as with carried interest.
tax its value upon grant like you would an option
???
Options are generally not taxed issuance.
Tax treatment of options varies depending on whether the option is an ISO or an NQSO. For NQSOs, on exercise, the optionee will recognize taxable ordinary income equal to the FMV of the shares on the date of exercise over the exercise price. The issuing company gets a deduction in a like amount. For ISOs, the optionee doesn't recognize any income on the grant or exercise of the option, and upon the sale of the underlying shares, the gain or loss is treated as a capital gain/loss (subject to holding period requirements). The issuing company doesn't get a deduction. In that way, for tax purposes, ISOs are quite like carried interests.
BTW, I'd also like to know how exactly you figure out the "value" of the carried interest, in order to determine the tax, upon grant of the carried interest in the first place.
"Tax treatment of options varies depending on whether the option is an ISO or an NQSO."
Al is referring to Incentive Stock Options versus Non-Qualified Stock Options, if memory serves.
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership. It is more analogous to the founder's equity provided to an entrepreneur starting a new company. Bill Gates didn't put up 20% of the capital in Microsoft and yet he owns 20% of the stock t(and will pay capital gains tax when he sells that stock).
It amuses me that once one focuses on the actual facts, the discussion of our capitalist overlords disappears.
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership. It is more analogous to the founder's equity provided to an entrepreneur starting a new company. Bill Gates didn't put up 20% of the capital in Microsoft and yet he owns 20% of the stock t(and will pay capital gains tax when he sells that stock).
It amuses me that once one focuses on the actual facts, the discussion of our capitalist overlords disappears.
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership. It is more analogous to the founder's equity provided to an entrepreneur starting a new company. Bill Gates didn't put up 20% of the capital in Microsoft and yet he owns 20% of the stock t(and will pay capital gains tax when he sells that stock).
It amuses me that once one focuses on the actual facts, the discussion of our capitalist overlords disappears.
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership. It is more analogous to the founder's equity provided to an entrepreneur starting a new company. Bill Gates didn't put up 20% of the capital in Microsoft and yet he owns 20% of the stock t(and will pay capital gains tax when he sells that stock).
It amuses me that once one focuses on the actual facts, the discussion of our capitalist overlords disappears.
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership. It is more analogous to the founder's equity provided to an entrepreneur starting a new company. Bill Gates didn't put up 20% of the capital in Microsoft and yet he owns 20% of the stock t(and will pay capital gains tax when he sells that stock).
It amuses me that once one focuses on the actual facts, the discussion of our capitalist overlords disappears.
Get rid of the wedge between cap gain and ordinary income rates, or at least reduce it greatly. Anyone who has actually studied the issue (not to include Publius et al, who are of the worship-the-vital-essences-of-our-heroic-wealthy school of economic analysis) knows that only a small fraction of cap gains are in startup or entrepreneurial ventures. There is not really a demonstrated link between cap gains and savings rates. Plus the cap gains/ordinary income distinction opens up all kinds of opportunities for creating unproductive tax shelters, gaming the complexity of the tax system, etc. All of that is totally unproductive activity and a waste of talent.
Carried interest is not a capital gain to the fund manager, because it's not a return on the fund manager's investment. Carried interest is variable compensation to the fund manager, that happens to be paid out of the fund's capital gains (same way that a corporation pays bonuses to its executives out of its profits). Carried interest is much more akin to a bonus than a capital gain, and should be taxed as such.
Bear in mind, the ostensible reason for taxing capital gains at a lower rate than ordinary income is to encourage new investment - not to provide an extra incentive for hedge fund managers to maximize returns (as if they didn't have strong enough incentives already). I happen to think the tax differential is an inefficient and unfair way to promote investment, and therefore think that it should be abolished; but that's another discussion.
As for the assertion that the financial industry would pick up & leave the US if hedge fund managers were deprived of this particular tax shelter ... evidence, please. There have been thousands of tax shelters over the years, that have come and gone while the finance business in NYC has continuted to boom. Give me a coherent, evidence-based justification as to why this tax shelter would be any different. Until then, that assertion is a complete red herring.
By the way, is 'Publius' Latin for 'repost as often as possible'?
Carried interest and options are fundamentally different. Options are a derivative contract provided by an employer to an employee. Carried interest is a differential division of profits agreed by two partners jointly creating a partnership.
You're kidding, right? You need to stop focusing on form and focus on economic substance. Carried interest is basically an option with a zero strike price--both give you risk-free access to the upside of an enterprise. Let's try to keep our eye on the ball here, people.
Options are generally not taxed issuance.
Ok, fine. Tax it as you would restricted stock.
I agree the PE industry would find a work-around, but if you make the PE fund a corporation don't you generate an extra level of tax? Your proposal will work for the fund managers but not the investors.
Most PE funds buy the bulk of their targets (i.e., over 80%), so I would assume a corporate PE fund would consolidated with its corporate targets and eliminate the additional level of tax.
Mr. Ninja,
I'm afraid that's just not right. There are plenty of substantive differences between carried interest and options. Options are an ability to buy more shares in a going concern (eg, a company). Carried interest is just a fancy way of saying that two parties in a partnership decide to split the economics by some means other than as percent of capital employed. Prior to the formation of the partnership -- the private equity fund -- there is no there there. The fund does not exist. This is a situation more analogous to an entrepreneur starting a company. One party has the ideas, the initiative, and the sweat to create value. The other party puts up the vast majority of the money. But the profits are the venture are not split according to contributed capital; they are split according to some different formula -- with the entrepreneur receiving capital gains treatment on his founders equity.
There are further distinctions: recipients of carried interest are not employees of the providers of capital. They are the general partners of a partnership and do not take direction. Recipients of options are employees.
Comments closed October 23, 2007.
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Heads in the Sand
Millions do good deeds every day, big and small, that make me proud to be human. Little to nothing happens making me proud to be a U.S. citizen. Living in a nation practicing genocide, torture and destruction of the enviroment on a massive scale tends to blunt your enthusiasm. Of course the sadistic fascists comprising the bulk of our citizenry make disagree with my assessment.
Posted by steve duncan | October 9, 2007 9:17 AM