US Lawmakers Urged To Rethink Carried Interest Tax Proposals

by Mike Godfrey, Tax-News.com, Washington

06 September 2007

The US Chamber of Commerce has argued that proposals to increase taxes on the carried interest earned by partners in certain funds would disrupt long-standing business practices in US capital markets, and risk undermining America’s pre-eminent position in the world as a leader in innovation.

Members of Congress have recently proposed increasing the tax rate on the general partner’s share of a limited partnership’s profits, known as carried interest, from the long-term capital gains rate of 15% to ordinary income tax rates of up to 35%, in an effort to restore fairness in the tax system between wealthy fund partners and other wage earners.

But in an analysis of the legislative proposals for the Chamber by Dr. John Rutledge, economist and Chairman of Rutledge Capital, it is argued that the measure would achieve little in terms of raising extra tax revenues, and would merely result in the cost of the tax increase being passed on to portfolio companies, negatively affecting all involved in the investment process.

According to Rutledge, venture-backed companies accounted for $2.3 trillion of revenue, 17.6% of GDP, and 10.4 million private sector jobs in 2006, while real estate partnerships have increased the availability and lowered the cost of capital to build homes, shopping centers, office buildings, and hospitals.

"Carried interest is a core element of partnership finance in every sector of the US economy engaged in capital formation, including real estate, private equity, hedge funds, healthcare, retail, distribution," Rutledge wrote.

"Increasing tax rates on long-term capital gains income designated as a General Partner’s carried interest would alter the long-accepted tax principle that partnership income flows through to the partners who pay tax based on the character of the income received by the partnership," he added.

An increase in the tax rate on carried interest would lead to "wholesale changes" in the structure of partnership agreements including loan-purchase arrangements, argued Rutledge.

Rutledge's analysis continued: "To the extent the tax increase could not be avoided by restructuring, the costs would be borne by all members of the investment process including general partners as lower after tax income, limited partners and their beneficiaries as higher costs and lower after-tax returns, and owners and employees of portfolio companies as lower business valuations."

"Increasing carried interest taxes would disrupt long-standing business practices in US capital markets and risk undermining America’s preeminent position in the world as a leader in invention, innovation, entrepreneurial activities, and growth. Raising tax rates would reduce the amount of long-term capital available to the US economy and undermine investment, innovation, entrepreneurial activity, and productivity."

Raising tax rates on the long-term capital gains of limited partnerships, said Rutledge, would drive capital offshore and hamper the ability of US companies to compete in global markets.

"In today’s global economy, countries have to compete for the capital they need to grow. Raising tax rates on long-term capital gains of US partnerships would hang a “not welcome here,” sign on our door," he warned.

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