July 11 (Bloomberg) -- The private-equity and hedge-fund industries are fighting a proposed tax increase by arguing it would hurt workers' retirement. The pension funds whose interests they claim to be defending aren't buying it.

Lobbyists for firms such as Blackstone Group LP, the Carlyle Group and Apollo Management LP have joined with allied Republican lawmakers and groups such as the U.S. Chamber of Commerce to attempt to show that higher taxes on hedge-fund and private-equity managers would cut into the returns of pension funds and threaten the retirements of police officers, nurses and teachers.

Pension officials and representatives of organized labor disagree and said the campaign is aimed only at giving lawmakers political cover to oppose a tax increase on a few rich investors.

``The argument that this is about the interests of retired public employees is ludicrous,'' said Orin Kramer, a hedge-fund manager who is chairman of the New Jersey State Investment Council, which oversees about $73 billion and aims to place 8.3 percent of its assets in private-equity firms and hedge funds.

Steven Kaplan, an industry expert who teaches finance at the University of Chicago, said that even though he opposes a tax increase, it is ``ridiculous'' for the industry to argue that higher taxes on the managers' share of profits would force hedge funds to be more cautious in their investments or find ways to pass the additional costs down to investors.

`Incentive'

``Once you have the money and you're investing it, your incentive is to make it worth as much as possible,'' he said.

Legislation co-sponsored by House Financial Services Chairman Barney Frank of Massachusetts and Ways and Means Chairman Charles Rangel of New York would tax the share of profits that managers receive for their services, known as carried interest, at ordinary rates of as much as 35 percent, rather than the capital-gains rate of 15 percent.

A separate Senate measure would require publicly traded partnerships such as Blackstone to be taxed at the corporate rate rather than the capital-gains rate.

Industry lobbyists and lawmakers such as Representative Eric Cantor, a Virginia Republican, are opposing the measure, saying pension funds, states and local governments have benefited from the high returns on their hedge-fund and private- equity investments. Republican presidential candidates including Rudy Giuliani and Mitt Romney also oppose the proposed legislation.

Lower Returns

Robert Stewart, a spokesman for the Private Equity Council, a Washington-based trade association founded by New York-based Blackstone and Apollo and Washington-based Carlyle, said higher taxes would inevitably lead to lower returns for all.

``If private-equity investors reduce their tolerance for risk because of higher taxes, it follows that their returns are likely to be reduced as well,'' he said.

Labor officials who oversee pension funds dismissed that argument. Damon Silvers, the associate general counsel of the AFL-CIO, the largest U.S. labor federation, said it was ``grotesque'' for fund managers to be taxed at a lower rate than other Americans, particularly given their huge payouts.

``The top 10 individuals who manage hedge funds made more money last year than the 80,000 New York public school teachers combined,'' Silvers said.

In addition, Michael Musuraca, who represents the public employee's union on the board of New York City's pension system, said the industry is overstating the amount that pension funds have invested as well as the effect a tax increase would have on returns. New York, for example, invests only about 5 percent of its $100 billion pension fund in private equity, he said.

`Extreme View'

``Suggesting that changing the tax status on carried interest would lead to public-sector pensions being jeopardized is taking a pretty extreme view of their importance,'' Musuraca said.

Some pension-fund officials said they agree the proposed tax increases may cut into their returns, though they still favor the change on the grounds of fairness.

Iowa State Treasurer Michael Fitzgerald, the custodian of the state's $23 billion pension fund, which has $2 billion in private-equity investments, said the industry's tax benefit ``certainly trickles down to having some benefit to the fund.''

Still, he said he couldn't ``justify why we should have that benefit when 95 percent of the investors in the world don't have access to these funds.''

Other representatives of public pensions are reserving judgment. Jeannine Markoe Raymond, the director of federal relations for the National Association of State Retirement Administrators, whose members are directors of public pension systems that oversee more than $1.8 trillion, said her group is reviewing the legislation.

`Range of Issues'

At the same time, though, she said, ``we understand that there are a range of issues beyond that of investor returns when Congress considers policy changes.''

Clark McKinley, spokesman for the California Public Employees Retirement System, said the largest public pension fund is ``watching the situation with interest.''

For the moment, only one Democratic presidential candidate, former Senator John Edwards of North Carolina, has supported the tax increase on hedge funds and private-equity firms. The party's leading contenders, Senators Hillary Clinton and Barack Obama haven't yet taken a position. Kramer, the New Jersey pension-fund manager, is a prominent fund-raiser for Obama's campaign.

To contact the reporter on this story: Alison Fitzgerald in Washington at afitzgerald2@bloomberg.net.

Last Updated: July 11, 2007 00:05 EDT