Timing of Levin tax measure raises questions

Rep. Sandy Levin (D-Mich.) stunned Wall Street, Washington tax lobbyists and even a few of his Democratic colleagues when he introduced a bill late last week to hike taxes on so-called “carried interest,” used widely in the private equity industry to compensate investment managers.

He unveiled the measure the same day that the Blackstone Group, the first private equity firm to go public in the U.S., started trading on the New York Stock Exchange. The lavish lifestyle of the firm’s chief executive, Stephen Schwarzman, had been widely chronicled in the press.

To many on and off Capitol Hill, the legislation — the second tax bill to target the alternative investment industry in a span of two weeks — seemed rushed to coincide with Blackstone’s initial public offering (IPO), perhaps even to throw cold water on it.  

Not so, said Levin: “I learned of this [issue] long before I ever heard of Blackstone.” Asked whether he knew the IPO’s timing, Levin said: “No, I didn’t know.”

The 13th-term congressman said he became aware of the treatment of carried interest, which is taxed at the lower capital gains rate of 15 percent rather than at ordinary income rates as high as 35 percent, back in April from an old friend from
Harvard Law School, Steve Wolfberg.

The two were having dinner with their wives at Wolfberg’s home outside Boston over the Easter break when Wolfberg, a longtime tax attorney, raised the issue with Levin.

“He described it and he thought it was not fair,” Levin said. The lawmaker returned to Washington and immediately dispatched his staff to research the tax treatment. He soon concluded it was “not fair” and called John Buckley, the Ways and Means Committee chief tax counsel, to discuss a legislative solution. Levin said he introduced the bill last Friday after the tax staff had been working on it for roughly two months.

“It was ready,” Levin said, “so I filed it.”

Still, some Democrats winced at the timing because of the appearance it may have given that the Democratic-led Congress was reacting to splashy headlines about Schwarzman rather than taking a cautious approach to a complex tax issue.

“I think there are some Democrats who were making observations about the race to public exposure and the timing [of the bill’s introduction] last week,” said one Democratic lawmaker.

Said another Democratic member: “There’s an argument that can be made that the introduction was premature.”   

Levin’s legislation follows a bill introduced on June 14 by Senate Finance Committee leaders Max Baucus (D-Mont.) and Chuck Grassley (R-Iowa) that was a direct response to the plans of Blackstone and a number of hedge funds to go public.
The legislation would boost the tax rates of all publicly traded investment partnerships, closing what the senators view as a loophole allowing such firms to be taxed at rates far lower than the 35 percent rate applied to most corporations.    

In contrast, Levin’s legislation would have a far more sweeping impact, affecting any investment management firm that pays its managers for the services they provide with a share of the investment fund’s profits. That share, known as the carried interest, would be taxed at the higher ordinary income rates rather than as a capital gain under Levin’s proposal. Tax staffers on the Senate Finance Committee have also been probing the taxation of carried interest in recent months.

Treasury Secretary Henry Paulson suggested on Wednesday that the Bush administration would oppose both the House and Senate proposals. He warned that raising taxes on hedge funds and private equity firms could have “unintended consequences” and said that Congress shouldn’t “single out” firms that go public, such as Blackstone.

Partnerships in a host of sectors, from venture capital to real estate to oil and gas, have long taken advantage of the lower rate for carried interest, causing some to wonder what prompted Congress to step in now. Levin cited the growth of the private-equity industry, but also the widened gap between income and capital gains tax rates due to the Bush tax cuts on capital income. “Tax equity and tax fairness has become a more prominent issue and that’s what caught my interest,” he said.

Aside from Levin, the bill has attracted the support of 11 Ways and Means Democrats. They include panel Chairman Charles Rangel (D-N.Y.) and Rep. Richard Neal (D-Mass.), the chairman of the subcommittee of jurisdiction. Rangel will hold hearings on the issue of tax fairness next month in which the carried interest proposal will be examined, Levin said.

A group of Republicans, led by Ways and Means and leadership member Eric Cantor (R-Va.), has begun to organize to fight the proposal. “To me this is nothing but an attempt to put a target on the back of an industry simply because they’ve been successful,” Cantor said. He said the group planned to educate other members on how “retirees across the country” would be hurt by the change because billions of dollars in public- and private-sector pension assets are invested in private equity funds. “I think this is just the beginning of what will be the tax fight of this year.”

Some Democrats seem to favor treading softly to avoid rattling investors. “It’s a little more complicated than maybe some have made it out to be because we have to have equity in this country for new technology and innovation,” one Democratic member of Ways and Means said.

Rep. Joseph Crowley (D-N.Y.) said he was glad that Rangel was taking a “studied approach” and holding hearings: “I would like to see any legislation move in a way that does not disrupt the markets.”

 Rep. Rahm Emanuel (D-Ill.), the Democratic Caucus chairman and a former investment banker, said he hadn’t made any decisions on the legislation and looked forward to the hearings: “The private equity industry and hedge fund industry — if you look at the last 20 years — have been increasingly helpful at making corporate America more competitive and keeping them on their toes.”

He added that the private equity industry’s tax treatment warranted study because of its explosive growth: “They used to buy a division of Chrysler; now they buy Chrysler.”