Clinton wants private equity firms to pay the same tax rate as working families, rather than the 15% they currently pay. At a rally in Keene, NH, she said, "Our tax code should be valuing hard work and helping middle-class and working families get ahead. It offends our values as a nation when an investment manager making $50 million can pay a lower tax rate on her earned income than a teacher making $50,000 pays on her income."
If she is elected president, Senator Clinton said, she will work to reform the tax code to ensure that carried interest "is recognized for what it is: ordinary income that should be taxed at ordinary income tax rates."
In my CNBC interview, I pointed out that private equity was being singled out because it was flaunting its wealth and its low tax payments -- in other words it was demonstrating that it did not understand how to play politics. Murray suggested that Congress ought to do "what's right" and challenged me to describe a principle for taxing private equity.
My suggestion was that society has an interest in putting capital at risk. Murray and I agreed that the 2% management fee is not at risk and therefore should be taxed as ordinary income – at the 35% rate.
During the debate, I did not think through clearly what I thought should be done about carried interest -- private equity's 20% share of the investment profits. But later that afternoon, I concluded that carried interest is a blend of at risk and not at risk profits, so it should be taxed in a blended way. To the extent that a general partner is putting his or her own capital at risk in a deal, then the carried interest in that deal should be taxed as a capital gain.
However, to the extent that the general partner is putting the limited partners' capital at risk, the pro-rata share of the carried interest should be taxed to the general partner at the ordinary income rate.
Simply put, since general partners put very little of their own money at risk, most of the carried interest is really a fee for managing other people's money. Therefore I pretty much agree with Senator Clinton.
But given the amount of campaign cash that both parties receive from firms that now pay 15% for their carried interest, I doubt the tax law will change. Reducing the cash flowing into politicians' campaign coffers would cost them their power. And no politician can afford to lose that.
Talking about this can help a politician win support from voters who don't pull in $50 million a year. So while I expect to hear continued rhetoric on this topic, I would be surprised to see a law pass that requires private equity to pay a 35% rate on its carried interest.
Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.
