bloggingbuyouts

"Score one for the barbarians" -- so reads the New York Post today. The reference, of course, is to Barbarians at the Gate, the sordid tale of the leveraged buyout of RJR Nabisco in the 1980s. Today, the private equity barbarians have won another battle: there will be no new tax on carried interest, at least not this year.

Charles Rangel, the House Ways and Means Committee Chairman has dropped a proposed change in the tax laws that would raise taxes on hedge fund managers. The change was relatively simple, raising the tax rate on fund profits and management fees from the current 15% to the 35% that corporations (are supposed to) pay. Needless to say, the private equity industry fiercely opposed the change, which would have raised $54 billion in new taxes.

The change in the tax code was part of a bill aimed at alleviating the effects of the Alternative Minimum Tax, which now affects 23 million households. The idea was to "fix" the AMT to keep it from being applied to broadly; the resulting loss in revenue could then be made up by increasing taxes on fund managers. But it looks like the managers are too powerful to allow that to happen, at least this time around. Hey, do you think this could have anything to do with campaign contributions and the growing political power of the newly gilded elite? Nah, couldn't be...

A group of minority and business leaders including former basketball star Earvin "Magic" Johnson plans to form a group called the Access to Capital Coalition to fight against efforts in Congress to end the tax advantages enjoyed by the hedge fund and private equity industry, according to the Wall Street Journal [subscription].

"Members of the new coalition argue that increasing the taxes on carried interest, also known as the carry, would reduce the incentives for private equity funds to invest and would make it harder to recruit top talent, particularly for small and midsize funds," the paper said. "Many of the new coalition's members run smaller funds that focus on investing in low- and moderate-income areas."

The U.S. Chamber of Commerce released a study today detailing the damage that these proposals could cause the economy, according to Reuters.

So, making hedge fund and private equity billionaires pay their fair share of taxes would somehow hurt poor people. I don't believe it and I doubt this coalition will do much to sway members of Congress. This issue isn't about taxation, it's about fairness.

Instead of paying the ordinary tax rates of 35%, these private equity and hedge fund managers pay the 15% capital gains rate on their carried interest. It's tough for most Americans to understand why one group of very rich people pays much lower taxes than another group of rich people. There is no political upside for any member of Congress to stick up for the industry, particularly as the presidential contest kicks into high gear.

There seems to be broad bipartisan support in Congress to close this loophole. It's not a question of if the industry pays higher taxes but when and how much.

As you can see from the numbers reported in The New York Times' DealBook, private equity firms are spending big on lobbying. Their goal? To avoid having to pay any more in taxes than they already are paying now. And it's easy to understand why they're so worried. There's no particularly good reason that large buyout shops should get better tax treatment than competitors like Goldman Sachs Group (NYSE: GS), so hand shakin' and deal makin' is their only hope.

Of course, the amount that they're spending is a pittance compared to the benefits they'll reap if it pays off. The Blackstone Group (NYSE: BX) tipped the scales by paying Ogilvy Government Relations $3.74 million for its efforts -- the firm spent a total of $120,000 all of last year.

The outcome of all this lobbying will be a true test of corruption in Washington. If the private equity firms are able to avoid being taxed at something resembling normal rates, we'll know that connections and money have won out over reason and fairness.

I admire the cleverness of Iowa Republican Senator Chuck Grassley's tax proposal. Bloomberg News reports that Grassley wants to introduce a bill that will link passage of a tax increase on private equity firms to an Alternative Minimum Tax (AMT) tax cut.

Grassley's proposal would increase from 15% to as high as 37.9% the tax rate that private equity firms pay on their profits with a measure shielding 23 million mostly middle-income households from an AMT increase this year. Unless Congress acts, the AMT will impose a $45 billion tax increase on 23 million households in 2007; permanently repealing the AMT would cost the government more than $1 trillion in revenue.

While it's not clear how much additional revenue the private equity tax rate increase would raise, the politics of the linkage is clever. That's because it will be hard for politicians seeking reelection to vote against a measure that could ease the lives of 23 million potential voters. If they happen to at the same time raise the taxes of those big campaign contributors, the need to help middle class AMT voters will offer the politicians some cover.

Peter Cohan is president of Peter S. Cohan & Associates He also teaches management at Babson College and edits The Cohan Letter.

In an editorial in today's Wall Street Journal, Steve Forbes makes the case for not changing the favorable tax treatment of private equity firms, even enormous publicly-traded ones like The Blackstone Group (NYSE: BX). The column, "Private Equity, Public Benefits," points out many of the great things that these firms do for society: "Between 1991 and 2006, private equity firms world-wide created more than $430 billion in net value for investors -- which include universities, charitable organizations and pension plans covering tens of millions of Americans. Thus the superior investments of private equity firms translate into stronger pension plans, more financial aid, and scholarships at public and private colleges, and more funds for research to cure or treat diseases."

Forbes is 100% right, and private equity has few bigger fans than this blogger. What Forbes fails to address is what makes these firms so special. Investment banks like Goldman Sachs Group (NYSE: GS) also have public shareholders, many of whom are teachers or police officers. Unfairly favorable tax treatment for private equity firms actually hurts these companies -- how can they compete with Blackstone when they have to fork over so much more in taxes?

There's no particularly compelling reason for the extremely favorable tax treatment private equity firms receive. Lots of businesses are great for America and they pay taxes too.