| | |
| Illustration: Greg Mably |
President Barack Obama might as well have held up a picture of Paul Singer or David Tepper while delivering his speech to Congress introducing the American Jobs Act. “While most people in this country struggle to make ends meet, a few of the most affluent citizens and most profitable corporations enjoy tax breaks and loopholes that nobody else gets,” said the president on September 8. “Right now, Warren Buffett pays a lower tax rate than his secretary—an outrage he has asked us to fix. We need a tax code where...everybody pays their fair share.” Obama’s jobs bill, coupled with the Joint Select Committee on Deficit Reduction—the so-called supercommittee tasked with recommending at least $1.5 trillion in deficit cuts over 10 years—has revived almost every tax idea bandied about by lawmakers in recent memory that could affect hedge fund managers. At least seven potential levies are in play: treating performance revenues as ordinary income instead of carried interest; an extra tax on the sale of a firm, better known as the enterprise value tax; a change to the so-called pass-through treatment enjoyed by various private companies, whereby managers would essentially be double-taxed because the firm’s profits would be taxed before dividends are paid; new limits on wealthy individuals’ deductions; higher marginal tax rates for the rich, including the so-called Buffett rule; a transaction tax on various investment activities; and the closing of perceived tax loopholes around so-called shell headquarters abroad and other offshore issues.
That’s enough to raise a hedge fund manager’s blood pressure. And plenty in the industry surely felt their heart rate increase when Obama put tax reform as a choice between “tax breaks for millionaires and billionaires” or putting “teachers back to work.”
That’s not to say all hedge fund managers are opposed to paying more taxes. “I wouldn’t object to changing carried interest treatment and [paying] other higher taxes if it helps get America back on track,” says Dinakar Singh, founder of TPG-Axon Capital and a Democrat. “But it’s hard to get behind what’s coming out of Washington when it feels like we’re being singled out for political reasons and it’s not part of more comprehensive tax and fiscal reform that would actually have an impact.”
But before America’s wealthiest investors go stock up on beta blockers, they should know none of the proposals will likely get passed. Nearly all have been brought up before only to die in Congress, leading most observers to believe they’re not going to become law this time either, especially with Republicans more tax averse than ever.
“Every firm on Wall Street should worry about tax attacks against capital, but the newest White House proposals on carried interest, enterprise value and pass-through have no chance to pass Congress,” says Michael Boland, president of Dome Advisors, a financial services–focused political research firm. “The White House knew they wouldn’t pass, but it needed them in their bill as ‘pay-fors’ to offset their new spending programs.”
The industry is on guard, just in case. Lobbyists have already briefed key members of Congress and their staffers on various tax issues since the financial crisis and are once again tracking the odds of the proposals becoming law.
The proposal creating the most nervousness is the potential change to the carried interest tax treatment. It’s in the jobs bill, and Democratic staffers on the House Ways and Means Committee indicated in early September that they would pursue it as part of supercommittee negotiations, according to an internal “revenue options” summary obtained by AR.
“I believe that there are persuasive public policy rationales for preserving different treatment of capital gains and of pass-through structures which align the interests of investors and managers, and you can be sure that MFA will be among those defending the measures,” says William Goodell, chief operating officer of Maverick Capital and new chair of the Managed Funds Association. “Removing incentive for longer-term investments will systematically increase required rates of return and shorten investment horizons. As managers of over $2 trillion of investment capital, our industry’s concern is that this change will have unintended and highly negative outcomes for the U.S. economy.” (For expanded comments from Goodell, see page 26.)
But like Singh, some hedge fund managers and insiders privately concede that they would not fight a change to carried interest alone. “As one of the people who will be directly affected by the proposed new rules, let me say that I wholeheartedly endorse them,” says George Soros of carried interest and Obama’s proposed Buffett rule, which would force those making more than $1 million to pay at least as much federal income and payroll taxes as those who make less.
But unlike the supercommittee proposal from Democrats, the jobs bill pairs the carried interest change with the enterprise value tax treatment, a controversial topic the MFA and others have aggressively portrayed as discriminatory. Previous attempts to pass carried interest largely failed because of the coupling.
The industry is also rattled by the potential elimination of the pass-through treatment enjoyed by partnerships like hedge funds. If the firm itself were forced to pay a tax on profits (as corporations do), the effective tax rate on individual shareholders—fund partners—would jump from approximately 35% to 45% or 50%.
Then there are the taxes that would affect all wealthy Americans. Few believe comprehensive tax reform will emerge from the supercommittee or Congress until after the 2012 elections, but that hasn’t stopped major changes from being proposed. The supercommittee could let the Bush-era tax cuts expire for the wealthiest Americans (those making $250,000 per year or more) or support the Buffett rule as part of a grand compromise. And under the jobs bill, deductions for the rich would be limited: Those with income of $200,000 ($250,000 for families) or more would have to cap the tax value of otherwise allowable deductions and exclusions to 28%, down from 35%. Both options have been floated before only to flop. Other provisions, such as a financial transaction tax like the ones being considered in Europe and changes to offshore domicile and tax rules, are also given minimal chance of passage by Washington observers.
Still, the MFA is on pace to spend more on lobbying this year than ever before. According to the Center for Responsive Politics, a nonprofit watchdog, the group spent $1.98 million in the first two quarters of 2011, more than half of the $3.72 million and $3.83 million it spent in 2010 and 2009, respectively.
Hedge fund employee ties to politicians through campaign cash will help push the antitax case on the Hill. Combined with the influence of like-minded private equity and venture capital firms, the industry will make its positions clear to key members of the 12-person supercommittee, which must come up with recommendations for a yes-or-no vote in Congress before December 23, 2011, or force $1.2 trillion in automatic defense and domestic cuts.
According to CRP, Sen. Pat Toomey’s (R-Penn.) largest donors this year include Elliott Management (second at $115,438) and SAC Capital Advisors (fourth at $46,100). Elliott is also a major donor to Sen. Rob Portman (R-Ohio), giving $90,368 in 2011, his third-largest booster. Sen. John Kerry’s (D-Mass.) top donor is private equity firm Bain Capital ($76,200); other major contributors include Blackstone (eighth at $76,200). Sens. Max Baucus (D-Mont.) and Patty Murray (D-Wash.) have also taken money from private equity and venture capital firms. On the House side of the supercommittee, Rep. Dave Camp’s (R-Mich.) two largest contributors are the Stephens Group ($67,500) and Blackstone ($46,300). Committee co-chair Rep. Jeb Hensarling’s (R-Tex.) 12th-largest donor is Maverick Capital ($10,000).
Some former Democratic boosters also appear to have soured on Obama. Managers like Dan Loeb of Third Point, John Arnold of Centaurus Advisors, Jamie Dinan of York Capital Management and Ken Griffin of Citadel all raised significant sums for Obama in 2008 but no longer appear on lists of the president’s current mega fundraisers, or so-called bundlers.
“Right now, it’s hard not to be disappointed by Washington in general,” says TPG-Axon’s Singh, who supported Obama in 2008. “I’ve grown disenchanted with Obama, but it’s hard to see a better alternative. I’m still evaluating.”
