Goldman Sachs CEO Lloyd Blankfein says it’s “emotion” that’s driving the Congressional push to change the tax treatment of private equity:
“Right now, sentiment is what is really transcendent,” Mr Blankfein said in an interview with the Financial Times. “But as you get into the consequences . . . for competitiveness and fairness . . . it turns away from sentiment.”
Blankfein is surely right that gut reaction to Steve Schwarzman’s big payday as Blackstone hits the markets today–about $700 million from selling shares, plus a $8.8 billion valuation (as of about 11:20 a.m.) for his remaining 23% stake in the firm–is one reason why Congress is interested in making him pay more taxes. But I spent a while yesterday reading through law professor Victor Fleischer‘s excellent analysis of partnership tax law, which has been read closely by the House and Senate staffers preparing the possible tax change, and it’s clear that there’s an entirely unemotional and to my eyes very persuasive case to be made for taxing the “carried interest” earned by general partners in private equity funds as ordinary income, not capital gains.
The case is one of consistency and fairness. Right now, our tax code is biased in favor of private equity and against corporations. A new CEO who is hired to turn around a public company, is given a big pile of options to motivate him, and succeeds in his work is taxed when he cashes in those options at the full 35% personal income tax rate. Yet a private equity partner who buys a troubled company using other people’s money, succeeds in turning it around, and then cashes in is taxed at the 15% capital gains rate. There’s nothing emotional about saying that this is inconsistent.
This whole thing is starting to remind me of the battle over expensing stock options. The move to treat options grants as an expense was initially driven by purest accounting logic. It didn’t actually gain enough momentum to become reality until emotion–in the form of outrage over the corporate scandals of 2001 of 2002–took charge. But those Silicon Valley executives who argue even today that options expensing was nothing but the product of East Coast envy (sorry for the lack of a link backing this up, but I swear I’ve heard these very words in a recent conversation) are dead wrong, and so is Lloyd Blankfein when he says sentiment is the main thing driving the private equity tax talk.
None of this means we shouldn’t have a serious discussion about the potential economic consequences of taxing private equity partners as employees. But I suspect that it’s the guys who don’t want their taxes raised who will be wielding the most emotional and sentimental arguments.