Thursday, July 26, 2007

Democrats shake down Wall St

Here's an exerpt of a good editorial from The Sun:

This morning, in the Cash Room of the Treasury Department, the Goldman Sachs chief executive-turned-Treasury secretary, Henry Paulson, will convene a conference on "Business Taxation and Global Competitiveness." Alan Greenspan will be there, as will some of the nation's top economists, including Martin Feldstein of Harvard and Michael Boskin of Stanford. Missing from the announced program are Senators Grassley, Schumer, and Baucus, and Congressmen Rangel and Levin. It's too bad, because were they to swing by they might get a glimpse of a Bush administration that is trying to help American business as opposed to a Congress that is determined to hamper it.

It's already the talk of Washington how Mr. Paulson tried earnestly to convince Mr. Baucus, chairman of the finance committee, that raising taxes on hedge fund and private equity managers was, in respect of tax policy, a bad idea on the merits. Mr. Baucus is said to have shrugged and said, never mind the merits, my leadership told me they need me to find $10 billion. No wonder the president of the Partnership for New York City, Kathryn Wylde, is, she told us yesterday, concerned that Washington is looking at this as an issue of revenue, where it should be a matter of international competitiveness. " Washington is not as sensitive to the fact that we now have to defend our jobs, business operations, and investments; this isn't just a matter of offshore call centers, we are talking about front office jobs," she said.

Democrats want to change the way private equity partnerships are taxed. Currently, they are taxed as capital gains, at the 15% rate. If the Taxocrats get their way, however, this will change for financial service partnerships to the corporate rate of about 35%.

Why are Democrats just now attacking private equity? The taxation of these partnerships has been the same for decades. The answer to politicians' behavior can best be identified by studying the incentives at play. What is the primary goal of a politician? To get re-elected, of course. And how does one get re-elected? By amassing gobs of money from lobbyists and donations!

So when private equity partnership Blackstone went public recently, the sharks started swimming. By threatening to more than double the taxation on these firms, these politicians would ensure that they got in on the buyout bonanza taking place on Wall St. Like naive companies before them, few private equity firms had lobbyists. Microsoft and Google were famous victims of forgetting to yield to the Washington extortion machine. They learned the hard way, after anti-trust suits and regulation threats, that if you make a lot of money and don't kick back to politicians in the form of donations and lobbyists, you get nailed.

It appears now, however, that upon paying their dues to their political masters, private equity firms may be safe from unfair regulation, for the time being.

Rest assured, the fundamental argument behind increasing the taxes on private partnerships is deeply flawed. Private equity partnerships invest in businesses, usually by buying all or most of an entire business. Some well-known companies that are majority (>50%) owned by private equity firms are Chrystler, Toys R Us, The Limited, Hilton Hotels, Burger King, Clear Channel, and my current employer, GMAC. Private equity partnerships invest by buying interests in these companies.

The companies owned by private equity are taxed on their profits at the corporate tax rate of ~35%. The profits are then taxed again on the private equity level at the capital gains rate of 15%. If the owners of the company choose to withdraw their profits in the form of dividends, they are taxed again at the dividend rate. Congress wants to increase the tax rate the partnerships pay on their capital gains from the carried interest from their investments. The Democrats claim that it is unfair that private equity firms pay "only" 15% cap gains while other companies pay the 35% corporate tax rate. While one can certainly argue the merits of axing the corporate tax, which is paid almost entirely by labor, the deceitfulness of Democrats is obvious. The private equity partnerships already do pay the corporate tax when the businesses they own pay their taxes. They then pay 15% capital gains tax on top of that, and, in order to see any of their profits, another dividends tax. This amounts to triple taxation! The Democrats think these private equity firms should be taxed even more, and in the name of "fairness."

Give me a break. What's fair about getting taxed three times on the same dollar?

Private equity buyouts play a critical role in our economy. Gaining heavy steam in the 1980s, leveraged buyouts allow smaller companies to purchase large, underperforming companies in order to maximize their assets. Their role is critical in that it doesn't just force businesses to out-perform their competition, but to fully maximize every opportunity lest they face a buyout from someone who can. Private equity firms oust bad management which sends an indirect threat to all other managers to perform lest they be next.

Furthermore, if the Democrats continue their over zealousness in attacking private equity, the firms are likely to simply set up shop offshore leaving nothing left to tax.

Clearly, putting additional burdens on these partnerships is not only bad tax policy, but reduces the competitiveness of American companies. One can see the greed displayed by the Democrat extortionists hungry to illegitimately get in on the profits of these partnerships.


tm said...

"The Democrats think these private equity firms should be taxed even more, and in the name of "fairness.""

You're missing the point. The question is quite simple: is carried interest cap gains or ordinary income? And it's fairly obvious that it's ordinary income. The managers don't own the asset being bought and sold; instead, their compensation is contractually tied to the gains they produce.

It's fee for service, and hence ordinary income, taxable at ordinary income rates.

As for the triple taxation thing: the investors get limited liability from the corporate form. The corp could be taxed as a massive DBA or as a partnership, but people will exchange the higher rate for protection. And managers take their slice pre-cap gains (you don't seem to understand how LPs work - the taxable event isn't at the partnership level; the gain passes through the LP, while the managerial fee is at the partnership level).

In discussing tax policy, it's advisable to know enough to not make yourself look like a fool.

Anonymous said...

Los Angeles private equity and hedge fund borrowing are the main things propping up the stock market these days. That won't last forever, but for now it's hiding the real economic damage that is being done.The tax issue is valid, and something most people can understand, but the real tragedy of the current situation is much more complex.