WASHINGTON (Thomson Financial) - US Senators struggled Wednesday to figure out whether hedge fund and private equity managers were paying their fair share of taxes on their immense profits, and what if anything Congress should do about it.
The Blackstone IPO, in particular, has prompted a populist reaction. "So the question arises," said Democratic Senator Max Baucus who chaired the finance committee hearing: "Is the income that these managers are earning properly capital gains income? Or are some people of great wealth merely taking advantage of the tax code to pay less than their full and proper share?"
The key question is how to tax so-called carried interest. In the standard "2 and 20" compensation scheme for private equity managers, they get a 2 pct annual management fee based on the funds assets and 20 pct of profits from the fund. The 20 pct is called "carried interest."
Critics contend that fund managers are more service providers than owners. In that case, they could be taking advantage of the tax law to change ordinary income into capital gains.
Various tax increase proposals, including treating at least some of the managers' or partners' profits as ordinary income instead of capital gains, are floating around Congress.
Treasury assistant secretary for tax policy Eric Solomon told the committee that such plans hold significant risks.
They could tax the same income twice and they reverse longstanding tax rules that apply to other partnerships such as real estate and energy.
"These rules have have operated successfully for many decades," he told the committee, and changes would discourage investment and entrepreneurship.
Republican Senator Charles Grassley said the tax reform bills aren't trying to single out one industry just because a lot of people in it got rich. He said there's also real concern about erosion of the US corporate tax base.
If they go public, Grassley said, he wants to be sure "firms that manage private equity funds and hedge funds will be treated no differently than their competitors or any other active business that goes public."
Senators had obvious struggles even to articulate their questions at today's hearing, an indication the complexity of this issue will deter action any time soon.
dennis.moore@thomson.com
dem/wash/dca
