Executives in investment management partnerships such as private equity, venture capital, real estate and hedge funds are nervously waiting to see whether Washington will follow through on a proposal to increase the tax when these businesses are sold.
The enterprise value tax proposed by President Barack Obama and some congressional budget negotiators is the latest fusillade against the investment industry. Already on alert against attempts to raise the tax rate on carried interest, industry lobbyists representing such partnerships say this latest twist makes them feel that they have a target on their collective back.
It “violates basic tax fairness policy and seems to single out the private equity, venture capital and real estate industries in a punitive fashion,” Steve Judge, interim president and CEO of the Private Equity Growth Capital Council, Washington, said in a statement.
The idea to raise the tax rate on general partners' profits, or carried interest, has become a perennial suggestion of federal budget cutters in recent years. This year's version first gained traction in the president's economic recovery plan. It got more personal for investment partnerships when Mr. Obama unveiled his American Jobs Act in September, which proposed increasing the tax on profits from the sale of investment management partnerships, known as the enterprise value tax. The proposals would subject those sales, as well as carried interest, to the higher income rate of up to 35% vs. the 15% capital gains rate used by other businesses.
Of the projected $12.5 billion to $21.4 billion in additional revenue from the two tax hikes, as much as two-thirds would come from the enterprise value tax alone, depending on who is doing the scoring.
Since carried interest represented a smaller slice of tax revenue, and therefore roused fewer opponents, industry lobbyists were resigned to losing that fight. “Among people who know more about carried interest, there is a very strong feeling that it is going to happen,” said Karl D'Cunha, senior managing director of investment bank Madison Street Capital, Chicago, who oversees services for asset management firms. “Whether it happens or not, you need to be prepared for it.”
The enterprise value tax idea started to take hold as asset managers enjoyed profits while the rest of the economy continued to sputter, Mr. D'Cunha said. “There is a negative perception of asset managers that they're able to generate a lot of income without paying taxes that similar financial services people would pay.” That resentment builds when partnerships set up offshore accounts to handle carried interest profits, “so the thinking is, "If we can't get them that way, let's get them when they sell the business'.”
Mr. D'Cunha has seen increased interest among clients for information on the enterprise value tax, and some are taking the threat seriously. Those who were thinking of selling “are trying to get transactions done sooner rather than later,” he said.
“It's definitely elevated from "not too concerned' to "moderately concerned,'” he said. “A lot are waiting until it gets closer before they start really getting worried.”
Mr. D'Cunha said that while his clients feel picked on for doing a good job for their investors, he and others concede they are an easy target, especially after the drubbing that other Wall Street firms took during passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. “It's almost like the hedge fund guys are next,” he said.
But the administration's bundling of the two tax hikes together could also be their undoing, because “it has galvanized people,” said a private equity executive who declined to be identified. “It's social engineering that singles out one industry.”
That stark cry has brought his industry some much-needed allies. In a letter to House and Senate leaders Oct. 20, NYSE Euronext CEO Duncan Niederauer warned that changing the 50-year-old 15% tax rate on selling partnerships “could have far-reaching unintended consequences on entrepreneurism, innovation and capital formation in the United States.”
The powerful Real Estate Roundtable in Washington, which represents a wide range of interests from mortgage bankers to real estate investment funds, has made carried interest and enterprise value tax hikes a top priority for its members, who make up 46% of such partnerships and represent roughly $1.3 trillion in equity investment that benefits workers and communities, they argue. Another compelling argument is the $13 million in political donations from real estate during the last election cycle.
Also in their corner are conservative groups like Americans for Tax Reform. Ryan Ellis, tax policy director for the Washington-based group, said the proposals are really “a shakedown. The ultimate goal is to raise the capital gains rate. Starting with private equity makes it easier to raise the rates, because it takes them out of the fight later on.”
For now, all tax hike proposals are in the hands of the Joint Select Committee on Deficit Reduction, the congressional supercommittee racing to cut the federal deficit by at least $1.2 trillion before Thanksgiving. Democrats notched a small victory recently when Republicans relinquished their long-held opposition to any tax increases by offering a package of relatively modest tax revenue proposals.
That philosophical change made investment services lobbyists more nervous about becoming targets. They didn't feel any safer when two prominent Democrats suggested significant new revenue from a tax on investment firm trading. Fifteen legislators, led by Sen. Tom Harkin, D-Iowa, and Rep. Peter DeFazio, D-Ore., introduced the Wall Street Trading and Speculators Tax Act bill on Nov. 2. The bill would raise $352 billion between 2013 and 2021, according to the Joint Committee on Taxation, a bipartisan panel that assesses the impact of legislative tax proposals, among other functions.
3 basis points
The new tax, which backers say is also being considered by the European Union, would charge three basis points on most non-consumer financial trading, and would apply to derivative contracts, options, forward contracts, swaps and other complex financial instruments. Too small to hurt the economy, the only real impact would be on high-volume speculative trading, and even that wouldn't hurt, sponsors say.
“Given the extraordinary profitability of Wall Street banks while the rest of the economy is suffering, there is no question that Wall Street can easily bear this modest tax,” the co-sponsors argued in a letter to supercommittee members.
Richard Baker, president and CEO of the Managed Funds Association, a hedge fund lobbying group based in Washington, disagrees. “The case history and economic policy arguments against instituting a global, or U.S.-based, financial transaction tax — reduced asset prices, the flow of jobs and trading to other venues, market distortion and reduced liquidity — have been well-documented,” he said in an e-mailed statement. “The imposition of such a tax, at this tenuous period, would only exacerbate the difficulties (and) it would impair those investors, pensioners and issuers who desperately seek efficient, liquid and well-functioning financial markets.”
With all the other big-ticket items being juggled by the supercommittee to trim the deficit and stimulate job growth, and hesitancy from leaders on both sides of the aisle to get into wholesale tax reform, industry lobbyists are hoping to stay below the revenue-hunting radar. “It's a low priority, but you always worry that something could get stuck in at the last minute,” said the private equity executive. “When you need every dime, who knows?”