Carried interest consumes US Capitol(2)

Capitol Hill set its sights on carried interest today, as two separate Congressional committees held exploratory hearings on or relating to the tax rate applicable to carry.

A bill has been introduced in the House which proposes treating carried interest as ordinary income, at a tax rate of 35 percent, as opposed to capital gains, which has a tax rate of 15 percent.

While its past two hearings on the matter focussed largely on whether carry is actually compensation for services and should be taxed as ordinary income, today’s Senate Finance Committee hearing explored how pension funds might be affected should the tax on carry increase.

Private equity funds likely lack the power to pass on to investors any additional costs stemming from increased taxes, said committee chairman Max Baucus, a Democrat from Montana who co-authored a separate bill proposing increased taxes on publicly traded partnerships like The Blackstone Group.

“The data says to me that hedge funds and private equity funds may need pension funds more than pension funds need private equity or hedge funds,” Baucus said.

Russell Read, chief investment officer for the California Public Employees’ Retirement System, said he was unable to predict whether increased taxes on carried interest will affect LPs, and ultimately pensioners.

“Due to the interrelated nature of the economics for a private equity fund, it is complicated to say generically how a change in one component will impact the total economics,” Read said in his written testimony. “As each fund is individually negotiated, an adjustment to one component will lead to offsetting negotiations on other components.”

Meanwhile, the topic was broached occasionally during the House Ways and Means Committee’s day-long tax hearing.

“Democrats are using Blackstone as a Trojan Horse to smuggle into law higher taxes on capital gains,” alleged Thomas Reynolds, a Republican from New York. “Anyone who thought the new Democratic majority might actually wait until 2010 – the year the lower rates on capital gains and dividends are scheduled to expire – to raise taxes on investments should be concerned.”

Among his reasons for opposing the bill are that “Main Street”, or ordinary Americans, would be adversely affected. (The Representative has a blog dedicated to the subject.)

“It helps bring the consequences of this proposed tax hike into focus when we remember that Grandma’s retirement security may be at stake,” Reynolds said.

The Ways and Means hearing was still ongoing at press time, with private equity professionals – such as Bruce Rosenblum, managing director at The Carlyle Group and chairman of the Private Equity Council, and Jonathan Silver, a managing director at Core Capital Partners – scheduled to testify last.