CU prof questions private equity profits

During a week when Kohlberg Kravis Roberts & Co. agreed to pay $25.6 billion for Greenwood Village-based First Data Corp. — the second- biggest leveraged buyout ever — some are questioning whether private equity firms are paying their fair share of taxes.

And one of the voices speaking in favor of increased taxation is University of Colorado Law School Associate Professor Victor Fleischer.

An editorial in Monday’s New York Times cites a recent paper by Fleischer presenting several arguments against the current U.S. practice of taxing private equity “performance pay” as capital gains, rather than as ordinary income. The distinction is important because capital gains are taxed at a modest 15% rate, less than half the rate of most other corporate and personal income.

Reuters, Bloomberg and Wall Street’s Dealbreaker blog also have picked up on Fleischer’s blog comments regarding the Blackstone Group’s proposed public stock offering, which is controversially structured to allow it to keep its favorable tax rates.

Private equity certainly looms as a large and tempting target these days. But what bothers most critics is not so much the favorable tax rate on the returns from “at risk” money used to fund the buyout deals. What really draws their ire is the industry’s customary “two and twenty” — a hefty 20% of deal profits and 2% of funds under management — that private equity managers collect for their services. Those fees also are taxed at the favorable 15% capital gains tax rate, rather than as ordinary income.

“This quirk in the tax law allows some of the richest workers in the country to pay tax on their labor income at a low rate,” writes Fleischer.

Private equity investors such as KKR, Blackstone, the Carlyle Group and Texas Pacific Group, having raised hundreds of billions of dollars in cheap capital in recent years, are now pouring it into a flurry of acquisitions at a record-setting pace. There’s much debate about whether deal values are getting too high, and about the ultimate social impacts as hundreds of companies are privatized, broken up, downsized and re-sold, often for huge profits.

Those issues aside, however, one reason for the recent private equity boom is almost certainly the favorable tax treatment these deals, and their architects, receive.

The New York Times editorial calls for Congress to address the issue of private equity’s “preferential” tax rate. And Sen. Charles Grassley (Rep.-Iowa) is reportedly considering just that. British lawmakers also are considering tax changes to collect a bigger share of private equity profits.

Fleischer, writing this week in the Conglomerate business law blog, says he’s “agnostic” about whether the preferential capital gains rate on private equity investment capital is appropriate. “But I certainly agree that allowing that preferential rate for capital gains on returns to human capital (i.e. labor income) is excessive,” he says.


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