Paulson on Private Equity + Hedgies

♠ Posted by Emmanuel in at 6/28/2007 12:49:00 AM

The clip above from the Wall Street Journal Deal Journal shows Treasury Secretary Henry Paulson defending the status quo of tax treatment for private equity and hedge funds at the WSJ's "Deals & Deal Makers Conference" [yes, well, what did you expect?] If you will recall, a raft of legislation on limiting the perceived tax advantages gained by private equity and hedge funds has made the news.
Democrats in the U.S. House of Representatives introduced a bill on Friday that would more than double taxes on the pay of managers of private equity funds, hedge funds and other investment partnerships.

Throwing down a challenge to some of the nation's savviest and richest financiers, the bill would set a higher tax rate for "carried interest." That is the 20-percent cut of profits beyond targeted returns typically kept by senior managers of private equity firms and other firms on major transactions.

The bill, introduced with the backing of two senior Democratic committee chairmen, ratcheted up a confrontation between Congress and the booming private equity sector, a driving force behind a global surge in corporate buyouts.

Under present law, carried interest is taxed at the 15-percent capital gains tax rate, not the income tax rate of up to 35 percent. The low tax rate makes carried interest a key source of vast fortunes for private equity's top ranks.

"Congress must ensure that our tax code is fair," said Michigan Democrat Sander Levin, one of the 14 lawmakers who introduced the bill.

"We have to be sure that the lower capital gains tax rate is not being inappropriately substituted for the tax rate on wages and earnings," Levin said in a statement.

Joining Levin in introducing the bill were Ways and Means Committee Chairman Charles Rangel of New York, and Financial Services Committee Chairman Barney Frank of Massachusetts...

Citing concerns about the Blackstone IPO, Senate Finance Committee leaders last week introduced a bill they say would close a loophole that allows private equity firms to float as publicly traded partnerships without paying corporation taxes.

The bill was co-authored by Finance Committee Chairman Max Baucus and senior Republican Charles Grassley. It would require publicly traded partnerships deriving income from investment adviser and asset management services to pay the corporation tax rate instead of the capital gains rate.

The Deal Journal adds the following commentary:

Private-equity honchos’ worried that the tax man is coming after them have a powerful ally: Henry Paulson.

At The Wall Street Journal’s Deals & Deal Makers Conference, the Treasury Secretary made it clear he is opposed to emerging efforts in Congress to raise taxes on publicly traded private-equity firms and hedge funds and the people who run them. Paulson was asked by the WSJ’s David Wessel about moves afoot in Washington that could raise the taxes private-equity executives pay to the ordinary-income rate from the lower capital-gains rate.

“This is not the approach that I believe makes sense,” Paulson said. “I don’t think it makes sense to single out one industry.”

(Speaking of private equity, here’s what Paulson had to say about the turmoil sweeping the leveraged-credit markets: “I clearly believe this is a wake-up call to focus on some of the excesses.” He specifically mentioned so-called covenant-light loans that give investors fewer protections against default. )

Paulson’s comments echo Glenn Hubbard, the Columbia Business School Dean and former Bush administration economic adviser. He said in an earlier appearance at the gathering that “the last time we tried to personalize the tax code we got the AMT.” He was referring, of course, to the Alternative Minimum Tax, the provision of the tax code put in place nearly four decades ago to clamp down on tax breaks for rich individuals.

With the Bush administration’s chief spokesman on such matters pooh-poohing higher taxes for private equity, Senators and members of Congress trying to “level” the income-tax playing field may have a high hurdle to clear.

Bloomberg also has more on Paulson's defense

Treasury Secretary Henry Paulson warned that raising taxes on hedge funds and buyout firms may have ``unintended consequences'' and said Congress shouldn't ``single out'' firms that go public, such as Blackstone Group LP.

``I don't believe it makes sense to single out one industry,'' Paulson said when asked about proposed legislation at a conference hosted by the Wall Street Journal in New York. Senate legislation would force Blackstone to pay taxes at corporate rates of 35 percent instead of as a partnership, with a burden as low as 15 percent. ``We need to be careful dealing with something like this piecemeal,'' Paulson said.

Paulson, the former chief executive officer of Goldman Sachs Group Inc., was the second senior Bush administration official today to raise concerns about efforts to increase taxes on many hedge funds and buyout firms. White House spokesman Tony Snow also suggested the administration will oppose such an effort.

``This is not an administration that's predisposed toward tax increases,'' Snow told reporters this morning. He said at a later briefing that he was speaking generally and wasn't addressing specific legislation. ``We're going to take a look at what Democrats have to offer,'' he said...

Shares of Blackstone, which traded as low as $29.13 about 15 minutes before Snow's first remarks, jumped 3.5 percent to more than $30.40 afterward. Shares of Fortress Financial Group LLC, the first hedge-fund manager to go public in February, increased as much as 6.2 percent after Snow's remarks. Shares of Blackstone fell 83 cents, or 2.7 percent, to close at $29.92 at 4 p.m. in trading on the New York Stock Exchange. Fortress shares gained $1.18, or 5.32 percent, to close at $23.25.

The tax structure of such funds has drawn congressional attention in the wake of billion-dollar paydays for fund managers.

The Senate legislation, introduced June 14 by Finance Committee Chairman Max Baucus, a Montana Democrat, and Charles Grassley, an Iowa Republican, would stop financial firms that become publicly traded partnerships from using a 20-year-old law that allows publicly traded investment firms that derive 90 percent of profits from passive investments to pay lower taxes.

The broader June 22 House legislation, backed by top Democrats, would tax the share of profits that managers receive for investment services at ordinary income-tax rates as high as 35 percent and affect all partnerships, public and private. Currently, that income, known as ``carried interest,'' is taxed at capital-gains rates as low as 15 percent.

The House bill, initiated by Representative Sander Levin, a Michigan Democrat, would also affect other partnerships, including those that invest in commercial real estate and oil and gas pipelines as well as venture-capital firms.

Although Paulson was asked about the Senate bill, he didn't distinguish between the two measures in his comments. More broadly, he said higher taxes on hedge funds and buyout firms would potentially affect other industries that use the partnership model. He also said the issues should be studied in the context of broader tax reform.

``We have tended to single out companies and industries to respond to the pressures of the moment,'' he said. ``We need to think comprehensively. We need to be careful of unintended consequences.''

Baucus and Grassley issued a joint statement later in response to Paulson's comments, saying their legislation is intended to equalize tax treatment, not target any one industry.

``We're simply clarifying that private equity firms and similar businesses should not receive special treatment in the tax code,'' they said. ``No one group of businesses should gain an edge over its competitors by subverting congressional intent and claiming a tax status for which they do not qualify.''

The Levin proposal is supported by House Ways and Means Committee Chairman Charles Rangel of New York and Financial Services Committee Chairman Barney Frank of Massachusetts.

Frank said fund managers are getting undue benefits from the tax code.

``I think they are getting a tax reduction they don't deserve,'' he said in an interview yesterday. ``I don't think you should be getting a capital-gains tax for managing other people's money.''

Levin's proposal has drawn sharp criticism from trade groups representing partnerships.

``It is a blow to capital formation,'' Jeffrey DeBoer, president and chief executive officer of the Real Estate Roundtable, wrote in a letter yesterday to Levin.

Lisa McGreevy, executive vice president of the Washington- based Managed Funds Association, the primary lobbying group representing hedge funds, said last week ``this is not about compensation for services. This is about the nature of long-term investment and capital formation.''

Earlier in the day, Michael Graetz, a Yale University tax professor who served in the tax department of President George H.W. Bush's Treasury Department, endorsed both the Senate measure and the Levin bill.

``I think it's odd'' that fund managers pay lower taxes on their labor income than their secretaries, Graetz told the Senate Finance Committee in Washington.

To nobody's particular surprise, the Bush administration has signaled that it will likely veto legislation aimed at reducing tax advantages for private equity and hedge fund operators. Paulson does represent the interests of the financial services industry. Remember, too, that 9 out of the top 10 contributors to the Bush re-election campaign were from the financial services industry. It's about par for the course whether you buy the official line that these operators diversify risk and create new opportunities for investors or not.