Private Equity Week’s Dan Primack has a good follow-up on the debate about the new tax for venture capitalists and other investors.
A public backlash against these investors is encouraging politicians: The extravagant ways of Blackstone, the buyout firm that that just went public and where leaders were feasting on $300 stone crabs, haven’t helped. The tax proposal is gathering momentum.
And while most investors are upset about the tax, New York venture capitalist Fred Wilson (pictured left) says the tax is justified:
I strongly believe that long term capital gains should be taxed differently than short term capital gains. And I also strongly believe that capital gains should be taxed differently than ordinary income. The counter argument is that the economic incentives to take risk with your capital should be enough and you don’t need additional tax incentives. I don’t buy that. Human nature being what it is, most people are going to want to be conservative with their capital. Taking a risk with your capital, particularly on new business initiatives (whether its a new restaurant in the neighborhood or a cure for cancer), is something we need to encourage. And many of the developed countries in the world agree. In some countries, capital gains are not taxed at all. I don’t think we need to take the economic incentives that far.
But, and this is a big but that will annoy most if not all of my colleagues in the VC and private equity businesses, if you are generating those gains with other people’s money (OPM), then that is a fee you are being paid and it should be taxed as ordinary income. I really don’t see how anyone can argue otherwise with a straight face.
If congress is successful in taxing carried interest as ordinary income, it will massively increase the amount of taxes I pay. So be it. Someone has to pay the taxes to keep our troops equipped, our borders secured, our schools modernized, and our children healthy. It might as well be me and my wife.
Meanwhile, here’s the statement by Mark Heesen, president of the National Venture Capital Association (NVCA), which represents 480 venture capital and private equity firms:
The Bill proposed today by House Democrats to change the taxation of carried interest from a capital gains rate to an ordinary income rate is extremely concerning to the venture capital community. We assert that carried interest in the venture capital business model is a true capital gain and should continue to be taxed at that appropriate level. This proposed legislation could have far reaching, negative implications for the start-up community, venture capital investment, and the US economy. It is critical that legislators identify and fully comprehend the unintended consequences of this proposal as it could impact one of the country’s most important economic engines. We look forward to continuing a dialogue with members of Congress on this issue as the legislative process continues.
Another concern is how these VC and other partnerships will respond to such a tax. Some may try to exploit loopholes that let them move their entities offshore but continue to invest here, for example. Experience has shown that you can’t just levy a tax and expect a corresponding increase in receipts. Congress should keep this in mind, and raise taxes only in a way that doesn’t mean a decline in tax revenues as a result.
8 Comments
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Larry Kudlow said:
Washington’s Tax War on Prosperity
Today’s precipitous stock market plunge—presently down over 150 on the Dow—is all about Washington’s war on prosperity.Make no mistake here: if the Democrats in Congress get their way, their punitive, soak-the-rich, tax hiking program would constitute the biggest attack on capital since the 1930s.
Two key, front-page, news stories (yesterday’s New York Times by Aaron Ross Sorkin, and this morning’s Wall Street Journal by Sarah Lueck et al) lay out the Democrats’ reckless strategy to essentially abolish the 15 percent capital gains tax preference for risk investing, and raise it by 20 percentage points to the already too high 35 percent corporate rate.
And, that’s not all.
The left wing’s broad based assault on wealth, investment, and savings would extend far beyond Blackstone’s successful Wall Street IPO today. The Democratic strategy would affect all private partnerships engaged in investment risk—this includes buyout funds, hedge funds, venture capital firms, real estate partnerships and oil & gas deals that qualify for the 90 percent passive income tax preference.
Their ill-advised strategy would strike a dagger into the heart of U.S. capital formation.
Nobody knows for sure whether Congress will green light these anti-growth ideas. The great presumption (and hope) is that President Bush would veto them if they did.
But right now, these newspaper reports are giving the stock market serious heartburn. The mere threat that Congress would embark on such a program of wealth destruction and economic impoverishment—all in the name of taxing rich people with the usual inside-the-beltway mantra of “tax fairness”—has investors reeling.
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steve said:
Being close to this situation (Fred is closer), it is really hard to parse how anyone can argue that ‘carried interest’ earns captial gains treatement. I can’t see how anyone less close to the situation (i.e. nearly everyone in America) will think this is the case — should they get to the point of thinking about it. Fred is right of course, and everyone knows it. Mark Heeson’s arguments are specious at best, fraudulently self-serving more likely. Bottom line politicians will trade-off potential donations today versus siding with the public. Outcome depends on the degree the media wants to invest in this story. I wish everyone was as pragmatic as Fred — do what’s right and get on with it. If the fund managers want true capital gains, get out there and invest their own money.
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Stephen Larson said:
Now I know why I change CNBC to the People’s Court when Larry Kudlow’s show comes on.
Larry’s “Tax War on Prosperity” diatribe tries to make people think investors in these funds will be paying 35%, sorry Larry, but that is not the case, it’s the managers who will no longer be paying the super low 15% on their compensation. The real investors will still pay 15% on their gains.
I guess Larry’s role of being against any thing taxes in the cable world is like Lou Dobbs’ role of being against anything immigration (”illegal” - sorry Lou).
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Stephen van Egmond said:
“Congress should keep this in mind, and raise taxes only in a way that doesn’t mean a decline in tax revenues as a result.”
What shameful doublespeak. You might as well be directly campaigning for new, and better, loopholes. Believe me, if there was any notable tax advantage to parking your corporation in Tuvalu, there would be articles here on “Ask the VC” dealing with questions of Delaware vs. Tuvalu.
Many people in VC are millionaires. They can retain their dignity by avoiding the cheapskate millionaire routine. You’re not entitled to your 57%-off tax loophole, and you demean yourself by claiming that it is staving off the End of the Stock Market as We Know It.
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Joe said:
Steve is absolutely correct. I am an MIT EE and Harvard MBA, with a Masters in Mathematics and Economics. Look at this from fundamental principles
1) a VC or PE partnership’s job is to manage money. They invest other people’s money. This is essentially a passive investment. they don’t start companies or run them, or design products or invest things, sell products. They are simply an investment vehicle for other’s money.
2) Given above, then what they get paid for doing that job is simply a salary. Nothing else. The fee is their base pay and the carry is their performance bonus.
3) If the investment results in a capital gain i.e. a start up company goes public or sold or a PE company gets sold then this gain which must be treated as capital gains must go to the investor. The investors are the LPs.
4) Therefore, only person or entity that can get the Capital Gains treatment is the actual source of money - i.e. the endowment or the pension fund or any other LP.
5) Definitely not the Fund-of-Funds. They are simply middlemen or brokers.
6) The only other people who get Capital Gains treatment are the founders / management
In the above logical and economically, socially and morally correct reasoning, there will be no dearth of funding sources. The actual people or entities with the money - i.e. the real LPs are still motivated to make risky investments. Just not with greedy car salesmen as the middlemen. There are plenty others with good qualifications who will be the middlemen without a capital gains treatment of the carry, as the source of these funds are motivated to invest.
These new managers will be working for the investors on a salary and bonus which by any stretch of the imagination is very lucrative. So there will be highly qualified takers.
Thanks you
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Joe said:
errata
First point - Third line
should read “invent” not “invest”
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Joe said:
ERRATA
First point, third line above should read
“invent” not “invest”
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Allan Grinshtein said:
Larry is completely right. What’s more, the idea that Blackstone’s success and guiltless exhibition of wealth should be cause to take them down a notch, take more of their hard-earned dollars, and redistribute it, is horrible.
