Plan to boost tax rate for managers hit

Investment executives said Thursday that proposals to raise the taxes paid by private equity and hedge fund managers would harm the economy and financial markets.

“There is no justification” for changing the way managers are taxed, said Bruce E. Rosenblum, chairman of the Private Equity Council and managing director of the Carlyle Group, in testimony before the House Ways and Means Committee.

Two committees on Capitol Hill are wrestling with the question of whether he’s right

In investment partnerships, managers typically get 20% of the profits -- known as carried interest -- and those are taxed at the 15% capital gains rate rather than the ordinary income rate, which can be as high as 35%.

Under a House bill with several sponsors, including Rep. Charles B. Rangel (D-N.Y.), chairman of the Ways and Means Committee, the managers’ profits would be taxed at the higher income rate. Senate members are considering a more limited measure, applying only to private equity firms that go public.

The issue caught on after news accounts revealed vast earnings at private equity firms, which take over troubled companies and try to turn them around and sell them for big gains.

The industry and some investors, such as venture capitalists, have been waging a counterattack, contending that the capital gains tax treatment is appropriate in light of the “sweat equity” they put into their holdings.

The U.S. Chamber of Commerce jumped into the fray this week by releasing a report that said the proposed tax hike would hit at least 15.5 million American investors in 2.5 million partnerships.

“Literally thousands of companies would not exist today were it not for the venture capital support they received early on,” said Jonathan Silver, founder of Core Capital Partners in Washington.

The view is not universal, even among affluent investors. “I don’t think it’s fair for . . . teachers and firefighters to subsidize special tax breaks for me and other venture capitalists. Or for private equity and hedge fund managers,” testified William D. Stanfill, founding partner of TrailHead Ventures in Denver.

Apart from the fairness issue, a central question shaping the debate is whether hiking the amounts paid by private equity and hedge fund managers would trickle down to retirees and other investors in the form of higher fees or lower returns.

Estimates vary on how many pension funds have stakes in alternative investment vehicles, but all agree that the numbers have risen sharply in recent years.

Experts suggested Thursday that the effect would be limited, but otherwise were vague. Taxing carried interest as ordinary income could push up fund costs by 0.1% to 0.2% a year, said Alan J. Auerbach, director of the Center for Tax Policy and Public Finance at UC Berkeley, adding that firms might devise ways to avoid such taxation.

“I’m concerned that at least some of the costs would be passed on to pension fund investors -- though it’s hard to say how much,” he said.

At one point, Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, pressed an executive from the California Public Employees’ Retirement System for a clear-cut answer. “If you do not know what the effect will be, it sounds like it would not be very great,” Baucus said.

Russell Read, chief investment officer at the $240-billion CalPERS, which has a growing private equity stake recently valued at $17 billion, said the answer was not yet clear. “My personal expectation is that this will be a factor. How large it will be is really difficult to know,” Read said.

Given the uncertainties, some lawmakers expressed doubts of pushing forward with plans for a tax hike.

“It seems to me we were brought to this hearing because of the extravagant lifestyle of one person,” said Sen. Gordon H. Smith (R-Ore.) in an apparent reference to Stephen Schwarzman, chief executive of the Blackstone Group, who earned some $400 million last year. After Blackstone become a public company in June, Schwarzman’s ownership stake was valued at about $7.5 billion.

Smith cautioned fellow lawmakers against taking a “sledgehammer” to the tax issue.

jonathan.peterson

@latimes.com