Sen. Max Baucus, D-Mont., has forged a set of clippers, and he’s headed for the hedge funds staking out a larger share of U.S. equity markets.
Last week, he and Sen. Charles Grassley, R-Iowa, introduced legislation that would significantly change the way private equity funds would be taxed should they go public. Although it’s too early to tell how much revenue might be on the table, their proposal has become Topic A in the financial press. Working out the political equations will be every bit as fascinating as the financial mathematics.
The gist of the Baucus-Grassley bill is this:
Returns on private equity capital gains are taxed at 15 percent. Fortress Investment Group, which went public in February, and Blackstone Group, which has its initial public offering set for next week, assert that is the correct treatment of their income.
Baucus and Grassley say the appropriate tax rate is that paid by other public corporations – up to 35 percent. If the nature of the services delivered – investment management – is the same for corporations and the newly public partnerships, they argue, the tax rate should be the same.
The private equity taxation issue has simmered for some time. Blackstone’s announcement that it will go public by selling stock worth an estimated $4.75 billion, depending on pricing at the time of sale, brought it to a boil. That would put Blackstone’s total valuation at more than $32 billion, and the value of chairman and founder Stephen Schwarzman’s holdings at more than $7 billion.
That kind of money draws attention, and it did not help Blackstone or Schwarzman that he is not one to conceal his wealth. He may be entitled – he founded Blackstone with just $400,000 – but high-living is ill-advised when Democrats in control of Congress are stewing about income inequity. A recent birthday party was emceed by comedian Martin Short.
But, as Eastern Washington University Professor Grant Forsyth notes, the legislation is probably less about fairness than it is about the potential cost to the U.S. Treasury if one class of investment income gets preferential treatment.
If Congress does not clarify the tax status of public partnerships early, he says, more companies could seize on the loophole perceived by Fortress and Blackstone, with serious revenue implications.
“It’s going to be institutionalized very quickly,” Forsyth says.
Baucus had been agitated about what he calls a “tax gap” before he became chairman of the Senate Finance Committee, where he is now in a position to do something about it. With ranking committee Republican Grassley on board, and the chairman of the House Ways and Means Committee interested, his bill has a good shot at passage. How anti-tax President Bush responds is another matter.
His Treasury secretary, Henry Paulson, will have some insight. He left the chairmanship of Goldman Sachs to join the administration last year. Goldman is one of Wall Street’s leading investment banks and is subject to the corporate tax rates. A lower rate would give Blackstone an advantage over his old haunt.
Treasury has been asked for its opinion of the Baucus-Grassley bill. That could be interesting reading.
Out on the campaign trail, you have one candidate, Democrat John Edwards, who earned $1.7 million in pay and investment income from Fortress. His investment in Fortress is worth around $16 million. Sen. Hillary Rodham Clinton has received private equity funding.
On the Republican side, Mitt Romney founded a private equity firm, Bain Capital. Employees of Bain and another firm have kicked $170,000 into his coffers. Rudy Giuliani has received $195,000 from officers and employees of another fund.
Now that private equity managers have awakened to the threat of more taxes, their contributions are expected to increase. It’s a long way to November 2008. Senators and representatives hate to bite the feeding hand.
Indirectly, the state of Washington could have something at stake in all this. The Investment Board has committed $400 million to a Blackstone investment fund. Conceivably, management fees could increase if Blackstone costs increase thanks to the higher tax burden.
The board also has $4.8 billion invested or committed with Kohlberg Kravis Roberts & Co., the granddaddy of private investment funds, which so far has given no indication it would go public.
The state’s private equity investments have been extremely productive, yielding $11 billion in profits since 1981.
Nothing wrong with profits, public or private.
But as Grassley has seemingly discovered for the first time, failure to equalize the corporate and public partnership tax rates “would leave other individuals and business taxpayers with a greater share of the nation’s tax burden.”
Bring on the clippers.