Rubin Says Fund Managers Should Pay Higher Tax Rates (Update1)

By Ryan J. Donmoyer

June 12 (Bloomberg) -- Congress should more than double tax rates for many hedge fund managers and private equity partners who classify their pay as capital gains, former Treasury secretary Robert Rubin said.

The Clinton administration official, speaking in Washington at a conference on tax reform hosted by the Hamilton Project, said fund managers are paid to perform services. Their share of future profits earned by managing other partners' money, called ``carried interest,'' probably should be taxed at rates as high as 35 percent, like normal salaries, instead of the 15 percent rate for capital gains, they said.

``One very good argument is to be made for treating it as ordinary income,'' said Rubin, now chairman of the executive committee at Citigroup Inc. Fund managers are ``basically performing a service,'' he said.

The 15 percent tax rate paid on carried interest by many fund managers is attracting congressional attention as lawmakers search for revenue to pay for spending priorities at a time when many fund executives reap billion-dollar paydays for a single year's work.

Lawrence Summers, who succeeded Rubin as Treasury secretary, said he was also concerned that some fund managers are able to abuse tax laws to convert some forms of income that should be taxed at higher rates into capital gains.

Mark Prater, chief tax counsel for the Republican staff of the Senate Finance Committee, said aides have been studying the tax implications of the structure for several months and will forge a ``piecemeal response'' to the issue.

Top Fund Managers

James Simons, 69, chairman of Renaissance Technologies Corp., earned $1.7 billion last year, Institutional Investor's Alpha Magazine reported in April. Citadel Investment Group's Kenneth Griffin, 38, earned $1.4 billion to place second last year, and ESL Investments Inc.'s Edward Lampert, 44, was third with $1.3 billion.

The average compensation of the top 25 hedge-fund managers rose 57 percent to $570 million and more than doubled from 2004. Those managers earned a combined $14 billion, about as much as Iceland's gross domestic product, according to Alpha Magazine.

The pay of private equity firm partners also is attracting lawmakers' attention. Stephen Schwarzman and Peter G. Peterson, who started Blackstone Group LP two decades ago with $400,000, stand to collect a combined $2.33 billion from the largest initial public offering by a leveraged buyout firm, Blackstone said today in a filing with the U.S. Securities and Exchange Commission.

Staff Review

A staff-level review at the Finance Committee has been studying the taxation of carried interest among several others, including how fund managers use offshore tax havens to defer large amounts of pay and the intention of Blackstone, seeking to raise $4 billion in its IPO to avoid the 35 percent corporate tax on most of its income.

Senate Finance Committee Chairman Max Baucus last month said he's ``nowhere close'' to having legislation affecting the tax treatment of private equity firms and hedge funds.

The typical fee structure for a hedge fund charges 2 percent of a fund's assets and 20 percent of future profits earned over a specified return amount. While the 2 percent is taxed at ordinary rates as high as 35 percent, the rest is taxable at the lower capital gains rates of 15 percent.

Great Britain

Lawmakers in Great Britain also are scrutinizing the private equity industry as some members of the U.K.'s ruling Labor Party and trade unions challenge the 10 percent tax rate that partners at buyout firms pay on the profit from their investments. The Trade Unions Congress is calling on Chancellor of the Exchequer Gordon Brown to make partners at private equity firms pay the top 40 percent rate instead.

``They're paying less tax than their cleaners,'' Labor Party lawmaker Angela Eagle told reporters after a meeting of the Treasury Committee today. ``It's indefensible.''

Summers, speaking at the Hamilton Project conference today, said fund managers often ``engage in false exercise'' when they attempt to argue that all forms of carried interest are a form of capital.

``Emphasis on simplicity is a passport to abuse,'' he said, although he added that ``not all profit-sharing is ordinary'' income, meaning that some of it should qualify for capital gains treatment. Rubin, a founding member of the Hamilton Project, which examines economic issues under auspices of the Brookings Institution in Washington, added that he didn't have a ``definitive'' answer for the issue.

Not Contributing

Rubin, a former chairman of Goldman Sachs Group Inc., said much of the problem stems from the fact that the top capital gains rate is 20 percentage points lower than the top rate charged on salaries. The lower rate on capital gains hasn't contributed ``one iota'' to the economy, he said, disputing claims of those who backed the lower rate in Congress.

Hedge funds and private-equity firms have poured millions of dollars into lawmakers' campaign coffers. About two-thirds of campaign donations from employees of the biggest hedge funds and buyout firms last year went to Democrats, Federal Election Commission records show. Last month, records showed that Democratic presidential candidate Barack Obama, an Illinois senator, raised more on Wall Street than Democratic New York Senator Hillary Clinton or Republican frontrunner former New York Mayor Rudy Giuliani.

Obama raised $479,209 from employees at the banks in the first quarter, according to FEC filings. Giuliani collected $473,442. Clinton raised $447,625.

Earlier in the day, Summers called for an overhaul of U.S. corporate taxes to counter slowing revenue from businesses. In a policy paper written with Hamilton Project Director Jason Furman and Jason Bordoff, the group's policy chief, Summers said declining revenue from corporations is contributing to growing income inequality among Americans.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net

Last Updated: June 12, 2007 16:16 EDT

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