WASHINGTON Prospects for legislation to raise the tax on the carried interest of investment partnerships appear to be gaining traction in Washington.
Three telling signs:
• A key pension group initially opposed to the legislation now is taking no position.
• An economic projection unveiled in Congress is undermining the argument that the tax increase would cause serious harm to investment returns of pension plans.
• The top executive at a private equity firm has come out in favor of the proposal.
Among those expected to oppose the legislation, leaders of the National Conference on Public Employee Retirement Systems, Washington, changed course and now are taking no position, said Robert D. Podgorny, president.
While some of our members feel that the bills could (adversely) affect the public plan community, the majority of our members do not share that opinion, Mr. Podgorny said in a Sept. 4 letter to Sens. Max Baucus, D-Mont., and Charles Grassley, R-Iowa, leaders of the Senate Finance Committee.
In an Aug. 14 letter to the committee, Hank H. Kim, NCPERS executive director and counsel, had written that the proposed tax could have enormous negative impacts on the economy, public pension funds, and the many public employees who depend on defined benefit pensions for their retirement security.
In an interview, Mr. Kim said some NCPERS members originally had encouraged the associations leadership to oppose the legislation. But after he wrote the letter to the committee, some public pension fund members of NCPERS said they objected to taking a position on the issue, Mr. Kim said. He declined to identify the pension fund officials.
No CalPERS position
At a Senate Finance Committee hearing Sept. 6 on the tax increase issue, Russell Read, chief investment officer of the $247.7 billion California Public Employees Retirement System, Sacramento, said the funds board also is unlikely to take a position on the legislation. Mr. Read said the board viewed lobbying on tax issues as being out of the pension funds purview.
We know it (an increase in the tax on carried interest) will have some effect, Mr. Read said at the hearing. How large of a factor is an open question.
The hearing by the Senate panel and another by the House Ways and Means Committee, also on Sept. 6, came as Congress considers two bills: A pending House bill would change the tax status of carried interest from current consideration as a capital gain to ordinary income, a switch that would have the effect of raising the levy to up to 35% from 15%. A pending bill in the Senate also would raise the 15% levy on some investment partnerships that go public to a top corporate rate of 35%.
Representatives of private equity firms and other investment partnerships have argued that the measures could undermine investment fund performance incentives and ultimately hurt pension plan beneficiaries by reducing plan investment returns.
But at the Senate Finance Committees Sept. 6 hearing, Alan J. Auerbach, a University of California, Berkeley, professor of economics, said raising the tax on the carried interest of investment partnerships to 35% is unlikely to reduce assets of pension plans by more than two basis points a year. Mr. Auerbach also testified that such a tax hike was unlikely to raise the costs of investment partnerships by more than 20 basis points a year.
Mr. Auerbach said he based his estimate on the ultimate impact a change in tax would have on pension funds on the fact that the assets invested by pension funds in investment partnerships is only a small portion of all pension fund assets.
If half of the tax increase were shifted to investors, this tax burden would imply a reduction of at most around two basis points in the annual return on these pension funds assets, and quite possibly less, Mr. Auerbach said.
Hedge funds and private equity funds may need pension funds more than pension funds need private equity or hedge funds, Mr. Baucus said during the Senate hearing. And that means that hedge funds and private equity funds may not have the economic power simply to pass along increased costs to pension funds.
In the House
In the separate hearing before the House Ways and Means Committee, Leo Hindrey Jr., managing partner of private equity firm InterMedia Partners LP, New York, endorsed efforts to raise the tax on carried interest.
A tax loophole the size of a Mack truck is right now generating unwarranted and unfair windfalls to a privileged group of money managers, and, to no ones surprise, these individuals are driving right through this $12 billion-a-year hole, Mr. Hindrey said, in written testimony. Congress, starting with this committee, needs to tax money management income what we call carried interest as what it is, which is plain old ordinary income.
Other investment partnership representatives warned the committee that proposals to increase the tax on carried interest could unintended consequences including encouraging private equity activity to move overseas.
Another possible consequence is that U.S. firms will become less competitive with foreign PE firms, and even foreign governments with huge investment war chests, Bruce Rosenblum, managing director of private equity firm Carlyle Group and chairman of the Private Equity Council, both in Washington, said in written testimony. The council represents some of the nations largest private equity firms.
As governments the world over are striving to make their tax systems more competitive to attract foreign capital and challenge U.S. dominance, this Congress is considering a proposal that would go in the opposite direction, Mr. Rosenblum wrote in his testimony.
On a related front, a coalition of minority and women money managers on Sept. 5 announced the formation of a new organization to lobby against legislation that would raise the tax on carried interest.
The organization the Access to Capital Coalition is arguing that the tax increase would hurt the ability of minority-owned investment partnerships to recruit talent, reduce the incentives for the firms to deliver and drive up the costs of capital for the small and midsized companies in which the smaller partnerships invest.
The carry is what people work hard for, said Willie E. Woods Jr. in a teleconference. He is president of private equity firm ICV Capital Partners LLC, New York, and chairman of the National Coalition of Association of Investment Companies, a Washington-based group that represents money managers owned by minorities or that invest in projects that benefit minority markets.
The Private Equity Council is among the new coalitions financial backers, Mr. Woods said.
The U.S. Chamber of Commerce, Washington, released a report earlier this month contending that raising tax rates on the long-term capital gains of limited partnership will drive capital offshore and reduce the productivity of American workers and the ability of U.S. companies to compete in global markets, the report said.
In todays global economy, countries have to compete for the capital they need to grow, the report said. Raising tax rates on long-term capital gains of U.S. partnerships would hang a not welcome here sign on our door.