Installment Two: Carried Interest as Part of a New Tax Plan
The following discussion on the "Carried Interest Tax Debate" is the second installment of a two-part series that analyzes the potential ramifications of a change in the tax treatment of an equity fund manager's carried interest against the backdrop of the impending United States presidential election.
Click here for Installment One.
As November 4 approaches, low on the list of issues important to the typical American voter is an increase in the carried interest tax. However, as discussed in Installment One, private equity funds have a far reach in the American economy, and accordingly, a change in the carried interest tax rate could have implications well beyond a fund manager's pocketbook. This article discusses the positions of the various United States presidential candidates on carried interest and the effect major campaign issues may have on private equity funds.
The Candidates' Tax Positions
Chuck Baldwin, Constitution Party
Baldwin's plan calls for a complete abandonment of the current tax system, including all income, corporate and capital gains taxes, including taxes on carried interest. Baldwin proposes funding the federal government with a return to a system of tariffs, excises and other such payments.
Bob Barr, Libertarian Party
Similar to Baldwin, Barr calls for an overhaul of the tax system. However, Barr proposes the gradual reduction and elimination of various taxes in favor of a consumption-based or flat tax rate. Although Barr has not addressed carried interest directly, he has proposed the elimination/significant reduction of the general income and capital gains rate distinction.
John McCain, Republican Party
McCain proposes no change to the treatment of carried interest as capital gains. As part of an overall plan that focuses on promoting lower taxes for businesses and corporate America, McCain's goal is to promote business development and job creation.
Cynthia McKinney, Green Party
McKinney has not stated a position on the capital gains tax or the carried interest loophole. However, her plan is to increase income taxes to fund hand-picked programs, and her voting record suggests that this could include repeal of the capital gains distinction.
Ralph Nader, Independent
As with McKinney, Nader has not made public his policy regarding the carried interest tax rate. Generally, he supports higher taxes on the wealthiest individuals, including the proposed "wealth tax."
Barack Obama, Democratic Party
Obama favors the treatment of carried interest as traditional income and implementing commensurate tax treatment over a short time span. Obama's position is part of a broader tax policy that calls for middle class tax relief by re-evaluating certain tax cuts and "loopholes" favoring larger business entities and wealthy individuals.
Private Equity Funds and Major Campaign Issues
Energy-Related Technology Research and Development
Central to many of the candidates' political platforms is the current American energy crisis. All of the candidates have clearly stated that new technologies in alternative energy, energy usage efficiency and global environmental impact are critical to the United States' future prosperity and independence. Historically, private equity has provided a significant portion of the funding for research and development (R&D) generally, with no signs of any change in this trend. Opponents of an increase in the carried interest tax rate claim that such a change would result in a reduction of the funding of R&D efforts, and thus a decrease in the number of new technologies developed both domestically and internationally. In response, advocates of the tax increase have proposed new programs to promote investment in research and technological development (such as Obama's plan for government contribution to university research). Advocates of smaller government, of course, would like to see control over R&D investments remain in the private sector, especially in the context of funding foreign operations, where potential political arguments over the use of funds are inevitable.
Small Business
The American middle class has received a lot of attention from the candidates in this election year. However, most of the proposed economic stimulation to bolster the middle class has come in the form of tax relief. Some argue that an increase in the carried interest tax rate would stifle private equity investment in small businesses if not offset by alternative programs and funding sources. Then there is the question of whether the federal government will be able to efficiently and quickly implement and oversee such programs. Some commentators contend that the impact of a tax increase will not materially impact small businesses, but instead merely reduce the return on investments to the funds or cause the funds to change their partnership structure.
Multi-Owner Real Estate Development and Management
The near-devastation caused by the crash in the sub-prime mortgage market has also been a focus of the candidates, and each of the candidates has set forth a plan for the regulation of lending to home buyers. Private equity will likely play a dramatic role in the real estate market going forward, specifically in the development and operations of new residential projects in metropolitan areas where multi-unit, multi-use developments are becoming increasingly popular. Private equity funds have served as supplemental capital for large multi-family developments and primary capital sources for smaller projects, and private equity often funds project and operations management companies who maintain these developments after the construction loans are repaid. Private equity funds will likely continue to fund these ventures, and could play an even larger role if traditional lenders remain hesitant to invest in such projects given current widespread security concerns. A change in the structure of private equity funds brought about by an increase in the carried interest tax rate could reduce the investments these funds make in residential projects without a counterbalancing, government-sponsored program which incentivizes investment.
Minor Issues with Major Impact
The American economy will undoubtedly be the core issue for November's election. Although the carried interest debate provides unique risks and opportunities for key markets, voters must look at a tax plan as a whole and not at each issue in a vacuum. It is easy to overlook the simple fact that every economic action, including changes in taxes, has a reaction, and any change suggested must be (and, fortunately, can be) allowed for elsewhere in the economic scheme. Therefore, a plan advocating an increase in the carried interest tax rate must provide for other incentives for private equity funds to remain active, or support for those areas which might suffer from a fall-off in private equity activity. The voters are now tasked with determining which candidate's plan will best serve these goals and the U.S. economy as a whole.
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