Last week, I had the opportunity to discuss the carried interest tax issue with Rep. Tom Reynolds (R-NY), who has been perhaps the most vocal opponent of change. He’s the Congressman whose office runs the From Wall Street to Main Street blog, and who often appears on CNBC to butt talking heads with Rep. Sandy Levin (D-MI). I still disagree with his position, but he articulated his rationale far better than did Levin during an earlier conversation.
To begin with, Reynolds is a Yankees fan. I only begin with that because our first 15 minutes or so centered around baseball. I’m a Red Sox fan. Moving on…
Reynolds’ primary argument against a change to carried interest tax treatment is that it could be the first step on a slippery slope toward an overall repeal of beneficial rates for capital gains. Not an increase back to Clinton-era levels, but an overall abolition. I’ve heard this argument over and over again from GOP sources, who sincerely believe that they must stand their ground on carried interest, in order to gain a foothold for future fights.
Reynolds also makes a secondary and tertiary case: (1) This is primarily being done by tax & spend Democrats to raise revenue; (2) This would force investment firms offshore, which would actually lower federal tax revenue. Kind of like Sabanes-Oxley redux.
It’s good Reynolds laid out his argument in that order, because it goes from strongest to weakest. He may well be right about the impact this legislation will have on the overall capital gains fight (coming soon, as current provisions sunset), from a political perspective. And I would agree with him that capital gains should continue to be taxed at a lower rate than is ordinary income. That said: This argument does nothing to address the fundamental inequity of current tax treatment of capital gains. Establishing one wrong to prevent a future wrong is… well, wrong. Moreover, there will be a much larger groundswell when “general” capital gains treatment arises, given the masses who have some sort of investment-derived income.
As for the tax & spend issue. I happen to think Reynolds is correct in saying that this issue originally came to the fore because of budget shortfalls. In fact, I recall NVCA president Mark Heesen talking about such things back in February. However, the issue has since morphed into an electoral one – as Democrats have slowly learned that the tax revenue bump will likely be minimal post-2006. In other words, Reynolds’ argument was stronger three months ago, before the credit crunch.
Finally, there is the issue of investment firms moving offshore. I just don’t believe it will happen. Will VCs leave Silicon Valley? Will buyout pros leave Manhattan? Again, we’re essentially talking about individual income rates, so places of residence and investment matter (not just where a fund is incorporated). I would, however, agree with Reynolds that most PE firms will attempt to find some way around the Levin bill (were it to pass) – which means that the extra tax revenue is more likely to come from law and accounting firms than from PE firms.
Reynolds said that he is not yet entertaining the possibility of a compromise bill, but seems pragmatic enough to consider it should the ground begin to shift a bit beneath the GOP’s feet on this issue. For example, Democrats could gain ground by asking the following question: “If private equity – and particularly venture capital – was able to thrive under the higher capital gains rates of the 1990s, why couldn’t it do so again?”
Reynolds didn’t have much of an answer for this one, save for switching over to the founders’ equity argument. But I’d expect he would soon, as my deconstruction of his argument belies its rhetorical power (at least coming from his mouth). In fact, I dare say he understands Sandy Levin’s bill better than Sandy Levin does. He’s simply reached the wrong conclusion.