June 23, 2007
Taxing Fund Managers
The Wrangle, Levin, et AL. bill, introduced yesterday, would double the tax paid by money fund managers on their "carry" in investment partnerships. They currently pay 15% (the long term capital gains rate); under the bill they would pay 35% (the ordinary income tax rate for entities). In political terms, fund managers made money too much too fast, were too public about their new wealth, and were late to fund political cover (contributions of politicians). The story of the tremendous new wealth of the founders of Blackstone, splashed all over the newspapers due to their IPSO yesterday, was the last straw. A tax the rich battle cry in a 2008 Presidential election and a new public identification of a new way to be rich produced the inevitable -- a proposal to double the tax on fund managers. At issue is whether such a tax can be put into the context of current tax rules. If so, the tax is a political and policy question; if not, the tax is a discriminatory, discretionary wealth tax on those who have recently acquired wealth (like a tax on anyone whose last name is "Buffet" or a tax on speaker fees of ex-Presidents that accumulate to over, say, $5 million ). To me it looks like the latter form of tax. The fund manager tax is a product of two other tax based distinctions that are interrelated: First, the double tax on "corporate entities" (a tax at the entity level and the investor level on distributed entity earnings) and the single tax on "partnership" like entities; Second, the distinction between income and capital gain (salary and investment returns). The new proposal, in essence, expands on the Backus/Crassly bill (that taxes the returns of all publicly-traded fund managers differently than privately held fund managers) and re-institutes a surrogate double tax on fund managers in partnerships by calling their returns income (instead of capital gains). The problem is, of course, that we, as most other developed nations, should not have a double tax at all. Entity returns, in all forms of entities, should be attributed to investors and taxed once. An argument for "taxing the rich" would appear in more progressive rates on individual returns. This indirect double tax by re-characterizing capital gains as income will have problematic consequences. In the simplest form of the argument, the tax penalizes that who contribute purely labor (those without capital) in partnerships (involving capital investments) in exchange for a split of the profits and leaves alone those who contribute pure capital. As an example, Ms. Operator, with no money, finds an under-priced commercial property, and solicits Mr. Moneybags to invest cash in a partnership, both to take an even split of the resale of the commercial property one year later (after renovation and marketing). Ms. Operator will do all the work. The tax bill hits Operator for a 35% tax and Moneybags pays only a 15% tax. At most, Operator should pay a 35% tax on foregone salary, and a 15% tax on the investment of the foregone salary. Taxing her on the total investment return as income makes no sense; she has the same investment risk as Moneybags. Penalizing pure labor, the clever, innovative folks with no money, has never been a good move -- aren't these the folks we want to encourage?? Moreove, those that can pay tax lawyers will work around the new tax. For example, Moneybags, as part of the original investment, "loans" money to Operator without recourse (this part will get fancy) and Operator invests the loaned money in the project. There will be many, many variations on this. The small partnerships who cannot pay the tax lawyers will be stuck. We have a "perfect storm" here; distrust of hedge funds, tax the rich progressives, new wealth in new patterns, concern over "private" ownership of large companies; a political campaign for control of the White House; a tax deficit with calls for new social spending programs (health care) -- and we are going to sink something, something of value.
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