With the first of several congressional hearings to come on private equity taxation happening today in 215 Dirksen Senate Office Building (hurry! hurry! you can still get there for some of the exciting action!), the WaPo (yesterday) and the NYT (today) both have articles on the vigorous lobbying campaign being waged by the private equity guys to keep their taxes low. The takeaway from both is that they really haven’t come up with any good arguments (other than money, which is always a good argument, I guess). In the Post, Virginia Republican Eric Cantor, who for some reason has emerged as a leader of the protect-private-equity-paychecks movement, had this to say:
This is a tax increase not only on those working on Wall Street, but also on all blue-jean-wearing Americans because of its effect on their retirement funds.
Well, not really. The vast majority of Americans, and by extension the majority of blue-jean-wearing Americans, aren’t covered by pension funds, which means that none of their retirement money is invested in private equity. Most also don’t send their kids to the colleges with big endowments that have benefited from putting money into private equity. And even for those who do get pensions, private equity is only a tiny piece of the investment pie. The California Public Employees Retirement System, the biggest American pension fund and among the first to put big money into private equity, has just 6.1% of its assets in the sector. Even if raising taxes on private equity general partners does depress returns for limited partners like CalPERS–a really big if–the effect on overall CalPERS investment returns would be pretty tiny. Now you could also make the argument that higher taxes on private equity would have some broader negative economic impact, and I’ll get to that in a moment, but I don’t think that’s what Cantor was saying.
In the Times today, the telling anecdote had to do with KKR’s Henry Kravis:
Meeting two weeks ago with Representative Sander M. Levin, a senior Democrat who is proposing to more than double the amount of tax that Mr. Kravis now pays, the buyout titan mustered his best arguments. He said that firms like Kohlberg Kravis Roberts play a central role in the economy, participants recalled, citing the example of how his firm had produced many jobs in Mr. Levin’s home state when it turned around a troubled electricity company in Michigan. He asserted that the lower tax rate benefited all Americans. And he said that an increase in tax rates would harm American competitiveness abroad.
Mr. Levin and his staff were unswayed. One aide asked Mr. Kravis to explain whether the measure would hurt workers and middle-income families by lowering the returns for pension funds that invest in Kohlberg Kravis funds, two aides at the meeting recalled. They said Mr. Kravis agreed with an answer by a partner that the proposal would not hurt returns, and the meeting ended soon afterward.
(An adviser to Kohlberg Kravis on Tuesday described the meeting slightly differently and said that Mr. Kravis said he believed the legislation could have an adverse effect on pension fund returns.)
I’d prefer to believe the first account, since it makes Kravis sound disarmingly honest. Which leaves only the broader argument that private equity and venture capital firms are good for the economy. This argument is not nonsense; private equity and venture capital firms almost certainly are good for the economy. But there’s really no evidence that taxing their general partners in the same way that corporate CEOs and Wall Street investment bankers are taxed would suddenly make all that economic good go away. It might, and maybe the few billion dollars a year the tax would bring in isn’t worth that risk (I don’t think the Joint Committee on Taxation has come up with any firm numbers yet on what the different bills introduced so far would bring in; at least I can’t find any in the big report the JCT prepared for today’s hearing, which you can download here.) Weigh that against the fact that the current favorable tax treatment of private equity partners’ compensation makes no logical or legal or moral sense, and you’ve got a tough argument for the private equity guys to make. Which appears to be why they’ve resolved to make largely specious ones instead.
By the way, CNBC is billing all its coverage of this private equity stuff as “War on Wealth.” What? Is Roger Ailes back? Well, I guess they know their audience.
Short-seller extraordinaire Jim Chanos was just on, mainly to talk about hedge fund regulation, and he sounded perfectly sensible when they asked him about the taxation of investment partnerships. Perhaps that’s because, as he pointed out, hedge fund managers who do any sort of active trading don’t get the tax break that their private equity peers do. His main point was that, if the private equity guys’ compensation were taxed as income instead of capital gains, the outside investors in private equity firms should get a corresponding tax deduction for the compensation expense. I’m pretty sure that would be the natural result of the tax changes being discussed in Congress, but it’s an interesting point. Pension funds and college endowments are tax-exempt anyway, but some other private equity investors aren’t.
Update: I’ve got yet another post on the subject here.
Update 2: Run, don’t walk, to The Epicurean Dealmaker for his trenchant take on all this. TED himself links to the post in the comments below, but I want to add my endorsement. Really, it’s brilliant.