POLITICS
08/19/2010 01:52 pm ET | Updated May 25, 2011

Buyout Firms In 'Grassroots' Lobbying Effort To Preserve Tax Loophole

The private equity industry is lobbying hard to convince members of Congress to lay off the tax scheme that allows investment fund managers to pay a lower tax rate than their secretaries.

The Private Equity Council, a lobbying group for private equity, is mobilizing fund managers to get members of Congress to come visit PE-owned companies in their districts to "showcase some of the industry's success stories," the New York Post reported Monday. (Private equity is arguably better known for buyouts and layoffs than creating jobs.)

At stake is the taxation of "carried interest," the 20 percent of a fund's investment profits that its managers take in on top of a fixed fee. Carried interest is currently taxed as capital gains at a top rate of 15 percent. House Democrats have long sought to tax carried interest like income, which has a top rate of 35 percent, only to see their proposals fail in the upper chamber.

But the Senate nearly closed the carried interest loophole this summer by attaching carried interest clampdowns to a series of bills reauthorizing extended unemployment benefits -- efforts that fell just short of overcoming a Republican filibuster. Senate Democrats have not signaled their plans but the carried interest piece is still out there, having been negotiated and tweaked several times, and theoretically they could pick it up to offset the cost of an upcoming spending bill.

"I think it will come back," said Nicole Tichon, a lobbyist for the U.S. Public Interest Research Group. "I found it interesting the [Private Equity Council] is allegedly having these grassroots meetings. It's one thing to make your case to the congressman, I think the harder sell is going to be to convince the rest of the taxpayers that fund managers deserve a tax break."

The Private Equity Council refuses to comment on its lobbying, but says "what has become clear is that more and more independent voices like KPMG and Ernst & Young are pointing out the unintended consequences of proposed carried interest and enterprise value taxation, which in turn are triggering broader opposition and concerns from small businesses, family partnerships, and corporations."

Experts say the attempt to point to small businesses is misdirected.

"Raising the tax rate on the fund managers won't impact the amount of activity in the sector in a meaningful way," said Victor Fleischer, a law professor at the University of Colorado who has written about the loophole. "The people who put up money -- the investors, the endowments, pension funds -- their tax rate will remain unchanged."

The group also launched a website earlier this year detailing the number of private equity-owned companies in every state and the number of workers employed.

"For every success story, there's a failure story which isn't being told," said Fleischer. "Private equity has done a reasonably good job with the companies they manage, but it's not like they're magical managers who do no wrong. Sometimes it's part of the strategy of the PE firm when they take over companies and want to improve efficiency, which is code for firing people."

Democrats have argued among themselves and extensively reworked their carried interest legislation. In Obama's first budget, raising taxes on carried interest was estimated to generate $23.89 billion in revenue over 10 years. When it landed in the Senate back in May, Democrats closed the loophole by only 75 percent, which would have raised $18.685 billion. In the next draft of the domestic aid bill, Democrats watered it down further by decreasing the amount of carried interest that would be taxed as income from 75 percent to 65 percent, and the bill raised $14.157 billion. Subsequent tweaks took it from there to $13.905 billion, and at last glance it raised $13.594 billion.

Steve Wamhoff, a lobbyist with Citizens for Tax Justice, is less optimistic that the carried interest change will happen. "The problem is these fund managers have such unbelievable power over senators, including Democratic senators," he said. The private equity, hedge fund, and venture capital industries solidly favor Democrats over Republicans with campaign contributions.

Instead of using the carried interest measure to offset the cost of a recent state aid bill, Democrats cut future funding for food stamps.

"I would also say there's not a lot of time left for this Congress to do anything," Wamhoff added.

Doing nothing would please the private equity crowd. Newsweek reported this week that Stephen Schwarzman, chairman of the Blackstone Group, said the proposal to tax investment fund managers like regular rich people is "like when Hitler invaded Poland in 1939."