Senators urge caution on carry tax change

Increasing the tax applied to carried interest could damage entrepreneurship and stifle America’s capital markets and competitiveness, according to the majority of witnesses and Senators at the US Senate Finance Committee’s first hearing on carried interest.

The first of a series of Congressional hearings exploring private equity’s tax treatment was marked by both Senators and witnesses urging caution regarding proposed changes to the tax treatment of carried interest.

As other committees examined aspects of the hedge fund industry on Capitol Hill today, the Senate Finance Committee’s standing-room-only crowd heard Kate Mitchell, managing director at Scale Venture Partners, argue that treatment of carried interest as capital gains is vital to the venture capital industry and well-deserved because of high risk factors involved in its investments.

Several questions specific to private equity and hedge funds arose during the hearing, though Mitchell stressed to the committee that venture capital is very distinct from other asset classes and did not speak on behalf of other partnerships that employ carried interest.

Following the hearing, Mitchell told PrivateEquityOnline she understands that representatives from those industries will be called to testify at future hearings on the matter.

Eric Solomon, assistant secretary for tax policy for the US Treasury, and Peter Orszag, director of the Congressional Budget Office, both repeatedly expressed concern over recently introduced legislation that would tax carry as ordinary income at 35 percent, as opposed to capital gains at 15 percent.

“We must be cautious about making significant changes to partnership tax rules that have worked successfully to promote and support entrepreneurship for many decades,” Solomon repeated at least four times during the hearing.

Senators from both political parties – including John Kerry, Orin Hatch, Mike Crapo, Jon Kyle, John Ensign and Charles Schumer – also noted concern. Schumer said that as a senator from New York, his constituents have been calling him continuously on the carried interest tax issue.

“I think it’s important that our tax code continue to provide incentives for risk-taking and entrepreneurship, because new ideas and new businesses create good jobs,” he said. “Another important consideration – a vital one as far as I am concerned – is that no matter what we do ultimately about these issues, the United States and New York City must remain the leading country and city in the world for financial services and capital formation.”

He added that he was worried one industry might be singled out for tax reform “simply because people in that line of work are making a lot of money or have their names in the newspapers”.

Hatch, too, said he was “very loth to tax partnerships just because the partners make a lot of money” – particularly given that “that money is not generally squirreled away in mattresses” but reinvested for the benefit of the economy, he said.

Aside from witness Marc Gergen, a professor at The University of Texas School of Law, the only individuals present who seemed markedly in favour of a change to the tax on carried interest was the committee’s chair, Max Baucus, and its ranking Republican member, Chuck Grassley.

“We can’t allow the carried interest tail to wag the capital gains dog,” Grassley said during his opening remarks. He stressed, however, that that the committee had yet to come to a decision and will hold further hearings on the matter.

Grassley and Baucus have already introduced legislation that would cause publicly traded partnerships, like Fortress Investment Group and The Blackstone Group, to be taxed as corporations, meaning they would be subject to two levels of taxes as opposed to one.

The issue was briefly discussed at today’s hearing, and will be further examined by the Senate Finance Committee at future hearings.

The powerful House Ways and Means committee, whose jurisdiction includes taxes and international trade, has also said it will hold hearings this summer on private equity.