What if We Didn’t Tax All of Carried Interest?

Now, Democrats want to cobble together what will likely be a failed attempt at a tax increase on all of private equity’s carried interest. Aaaagain. But they’re not seeing the forest for the trees. Well, particularly, the big, ugly monstrosity of a tree that stands to make most of the other trees look sleazy by comparison, that is, the dividend recapitalization. The dividend recap is one of the less savory things about PE, and lawmakers would be wise try to increase the tax rate of money derived from those transactions, rather than for all private equity deals—not that I expect a pack of legislators, some of whom came to Washington armed with little more than a limited worldview and a community college degree, to try to comprehend this unprompted. For one, it forces good management, and basically tells private equity managers: “You can run this company to profitability? Fine, you get taxed at a lesser rate. Even if you cut jobs? Fine, you get taxed at a lesser rate. But if you just load it up with debt and make its financial structure a burden onto the organization itself, then haul ass with a profit and leave something behind that bleeds jobs, you better believe you’re going to take a hit.” Even if a PE firm can dividend recap its poor, huddled portfolio to the exits, a more heavily-taxed revenue stream will be unappealing to LPs, who will also take note of the borderline irresponsible fiscal management.

Speaking of which, it is irresponsible for lawmakers to say they’ll increase carried interest across the board: the fate of too many public pensions are tied to the performance of private equity, and the doubling of the tax rate on the industry’s employees would drive talent from the asset class, effectively making pensions reliant on second-rate professionals (Which many already are, internally, amirite!?). Pensions, and ultimately, retirees, will suffer if a carried interest tax was passed—not just the so-called “one percent” Democrats will be denouncing from every mountable soapbox between here and November. If lawmakers want to have a shot at passing legislation that increases the federal government’s tax revenue without punishing an entire asset class, the dividend recap tax is the way to go. Finally, bonus points would be awarded by the electorate (and, myself) to the administration for finding worthy causes for these tax dollars up front. You know, not another Solyndra, the Post Office, or, for Pete’s sake, one more round of raises for our Congressmen and Senators.

Now, this won’t cover as much as an all-out tax on carried interest. So, where do you think the rest of what the government needs should come from?

1 Comment

  • While I agree generally, especially with regard to recap dividends, I take exception to the oft-repeated notion that if “talent” can’t continue to demand – and receive – ever more lavish compensation, all those smart people just might stay home. There will always be someone prepared to do a job for less than the present occupant. And just because that person will do the job for less does not make them ipso facto less qualified. Witness the increasingly high-level jobs that get ‘outsourced’ to India, China and Vietnam each and every day (many of them at the behest of PE sponsors).

    Going further, it’s a bit much to try and justify current levels of executive compensation by suggesting that we must protect our pension funds by preventing those “second-rate” talents (no doubt state college grads all) from working for less. To insure pension funds get the returns they need to take care of the little people, we’ve simply got to hire the best (read: most expensive) people that money can buy. So, soaring executive compensation is actually a social good! Noblesse oblige, right?

    Once again, you make the mistake of equating compensation with competence. A self-fulfilling prophecy if ever there was one.

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