The private equity guys offer some seriously lame arguments for keeping their tax break

In all honesty the only true argument that any PE, or Venture Cap group can make is that this legislation would set a precedent allowing for a push to tax all investment income under the standard tax code. Basically, by passing this legislation that would really put a dent into their personal income, our government would be opening the door to increasing taxes on all investment returns. Their pension argument is a feeble attempt to justify their huge paychecks, however they have found many ways to manipulate their income so it does not fall under the standard tax code. Who is to say that they won't find alternative methods to continue this trend and limit their tax liabilities even if legislation is passed to dissolve their current strategy.

This article is crap

That comment, on the other hand, is brrrrilliant.

You know Justin, I read the NY Times piece, and I just love the quote by Wayne L. Berman, managing director at Ogilvy Government Relations and a major Republican fund-raiser: "...It will be about rewarding risk and recognizing that when you reward risk you create economic growth.”

I believe even you've posted - or maybe not - describing how the way many recent PEs have changed the nature of risk they take on but not directly investing a good deal of their own capital, but rather leverage some significant debt in order to cover their deals.

I mean really how much risk have they been taking on????
Ok that's my rant for the day.

Dear Editor-

Were such a restructuring of the Capital Gains Tax Code to occur, such as to magnify the rate at which Private Equity Partners are taxed, the truly worrying possibilities occur within two categories of outcome. The first is the domestic evolution of Private Equity participation arrangement, while the second is the long-term result of the international restructuring of Private Equity Partnerships, of partners limited and otherwise, in jurisdictions of questionable or unsubstantial tax-regulatory practices.

From the perspective of domestic evolution it is important to note that pension funds such as CalPERS, as tax-exempt institutions, pay no taxes on the dividends or equity proceeds of investment; thusly, the impact upon their returns, all else constant, would be minimal. However, far more probable is that significant end-investor losses would result either from other economically significant factors. Two such key influences are 1) decreased performance incentive to Private Equity Partnerships, and 2) increases to management fees and 'carry' charged by Private Equity funds to offset the equivalent, negative financial impact to Partners of increased tax rates. The first impact is more academically theoretical, but emprically demonstrable to be of moderate size in contract and labor theory. It is the second that is most crucial and predicatble in terms of a (negative) impact of very significant magnitude upon the total returns, net of fees, to be distributed to shareholders. It is effectively a cost pass-through to the investor and there is no way, tax-status included, for pension funds [and indeed other investors] to recover this very large penalty to them. This policy of passing costs through is empirically strong and consistent amongst all private competitive sectors as one of the key bases for the pricing and re-pricing of goods, financial assets, and financial services.

From the international perspective, and as was noted by Mr. Brian Mowry previous to this response, Private Equity Firms are incredibly talented in the arena of circumventing regulation and, to the extent that it is possible, using cross-border regulation differentials to in fact create value at the expense of other [domestic] taxpayers. Were Private Equity, as an industry, to restructure in certain jurisdictions, it could design both basic and derivative contracts which take advantage of a new and existing tax treaties relevant to Federal and National withholding tax rates.

The financial structuring behind the efficient, but technically legal, abuse of inter-national tax and accounting codes quickly becomes commplicated but serves the foundation for some of the largest trades in today's financial markets unknown to the average market observer. By designing appropriately intermediated and sub-divided contracts, Investors/Funds/Firms with significant liquidity and tax capacity (accrued taxes payable on the year's operations) to reduce within a tax jurisdiction can not only avoid taxes all together from business dealings in one jurisdiction, but also claim additional tax credits from the originally punative jurisdiction such as to actually amplify the net financial position of the fund at the expense of the taxpayers.

Effectively, the Firm/Fund, along with a business partner, both claim tax credits where only one has been paid. They are not, however, inventing money; the amount of the second and equal tax credit comes from the treasury of the targeted country. These contracts, though complex and innumerable in potential structure and variety, are very possible.

The main point, through lengthy explanation, is not only that will Private Equity Funds find profitable ways around new tax codes (indeed they already exist), but their subsequent international restructuring as resident in foreign and lenient/ambiguous tax jurisdictions will likely result in the United States losing a massive financial base from which to claim federal taxes. The implied potential losses, in many highly likely scenarios, far outweigh the marginal gains to be had by targeting the incomes of the very few uber-rich.

Regards,

Alexander W. Scanlon
MSc Financial Economics, Oxford University
MPhil Management, Cambridge University

Dear Mr. Scanlon -- I have been hearing similar arguments throughout time that any attempt at changing the tax code in order to capture un- or under-taxed income will fail because the clever boots under attack will all move offshore. Sometimes--say, in the UK several decades ago when the Beatles and punitive taxation both reigned--the tax burden gets so great that it actually happens.

In most cases, however, the evidence is against wholesale offshoring of tax revenues, especially when the differential loophole closure is, as in this instance, relatively unpunitary (15% vs 35%; really). The reason is that it is very difficult, costly, and time-consuming to change your tax jurisdiction, and it puts a severe cramp in your social and economic life. Few people with the assets and wherewithal to do so really end up doing it.

Finally, even if all the PE professionals in North America crowd onto Grand Cayman tomorrow, what would be the loss? Sure, several hundred million (perhaps even billions) of annual tax revenue would disappear. A drop in the bucket, compared to IRS receipts, and no argument against creating a fairer tax code.

But the PE industry, and asset class, would not move offshore, nor would its economics change materially enough to weaken or destroy it for the investor LPs who pony up the capital PE firms use to conduct their business. Therefore, the tax base itself would not be seriously harmed.

Rich people and corporations always threaten to take their marbles and go home if government gets too uppity about taxing them. The problem for PE, however, is that the marbles in play are by far and away not theirs to take away.

http://epicureandealmaker.blogspot.com/2007/07/taxman-cometh.html