Carried Interest Gets A Hearing

Following a month of chatter, Congress this week finally begins debating the tax treatment of carried interest. On Wednesday, the Senate Finance Committee is holding a hearing. These hearings typically precede the adoption or rejection of legislation.

Quick recap: Lawmakers have suggested taxing carried interest as ordinary income (a 35% rate) rather than as long-term capital gains (a 15% rate).

The panel expects to hear from five well-positioned authorities, including Eric Solomon of the Department of Treasury, whose boss, ex-Goldman chief Hank Paulson, has gone on the record opposing the change. The Congressional Budget Office also has a witness on the card, most likely to say how much more money the government could collect if the tax change were implemented. The SEC is chiming in, too.

The private equity industry will have one representative, Kate Mitchell, a managing director at Scale Venture Partners and a member of the board of directors of the National Venture Capital Association. I wasn’t able to track down Mitchell before sending out the Wire, but presumably her testimony will be in keeping with what is surely an NVCA unified front against the proposed change.

The last speaker is Mark Gergen, a University of Texas Law School professor. Gergen, who spoke to me on Friday, said he considers the current treatment of carried interest an “anomaly” in the tax code that should be straightened out. Gergen has been making this point for more than 20 years. “It’s an old issue,” he said, noting that he wrote a paper in 2003 predicting Congress would make the change within a few years.

He plans to urge the panel to adopt a “simple fix” to 702(b)—the relevant part of the tax code—that would encompass not just buyout firms and venture capitalists, but also real estate partnerships and oil and gas partnerships. The upshot of his proposal would have PE pros pay the ordinary-income rate on carry.

Formal hearings aside, the political calculus for the proposed tax change is difficult to decipher. Democrats control the Senate by a razor-thin 51-49 majority, but several big Senate Dems (including Hillary Clinton, Chuck Schumer and Chris Dodd, all of whom count hedge-fund and private equity pros as highly valued constituents) have yet to weigh in on the issue. John Edwards, Democratic presidential candidate and former employee of Fortress Investment Group, came out over the weekend with a three-point plan for increasing taxes on hedge funds and private equity firms. Conventional wisdom says the GOP—Chuck Grassley notwithstanding—will turn its nose at anything that carries even the faintest whiff of a tax hike, especially since some in the party already suspect the carried interest debate is the opening salvo in a larger war to raise the capital gains rate for everybody.

But looming over the 110th Congress (as it did for the 109th, 108th, 107th and so on) is the alternative-minimum tax, the automatic income tax originally designed for rich families that now increasingly snares the middle class. Congress has blunted the full effect of the AMT by approving several small patches, but a comprehensive repeal has so far proven impossible, probably because it would deplete the treasury by as much as $1.5 trillion over 10 years.

According to one school of thought, raising taxes on exorbitantly wealthy private equity pros and hedge-fund managers would be a small price to pay for bailing out the middle class. It will be interesting to see if, on Wednesday, the CBO predicts how much revenue a tax shift on carried interest could bring to government. That number, though certainly far, far short of $1.5 trillion, could turn out to be a uniter, not a divider.