White House's Orszag Says Higher Tax on Fund Managers to Pass Within Weeks

Four Senate Democrats and Republican Scott Brown of Massachusetts are seeking to exempt venture capital firms from a tax increase on managers of investment partnerships that a White House official predicted is imminent.

Brown, along with Democratic Senators Patty Murray of Washington, Mark Warner of Virginia, Bob Casey of Pennsylvania and Jeanne Shaheen of New Hampshire, said subjecting venture firms to higher tax rates on so-called carried interest would hurt job creation and “could not occur at a worse time.”

Senate Finance Committee Chairman Max Baucus is considering adding the proposed higher tax rate on carried interest to broader legislation. Carried interest is the profit share paid to managing partners of firms as part of their pay. That share, which lawmakers say is payment for services, currently can qualify for long-term capital gains rates of 15 percent.

Investors who contribute capital to the funds wouldn’t be affected by changes in the tax on carried interest.

The five lawmakers voted for an earlier version of the broader legislation, which would help unemployed workers and renew popular tax breaks. That measure passed 62-39, with four Republicans joining all Democrats voting in favor. Any future legislation containing the carried interest tax increase would likely require 60 votes to pass.

“We encourage you to include language in any carried interest provision that maintains a capital gains incentive for those who contribute to the viability of our start-up community -- venture capitalists,” the senators wrote in a May 11 letter to Baucus and Iowa Senator Charles Grassley, the top Republican on the finance panel.

Build America Bonds

The senators stopped short of saying they would oppose the broader measure if it includes the tax increase on fund executives. The broader bill would extend the Build America Bonds program and renew a tax credit for business research expenses.

Larry Smar, a spokesman for Casey, said Baucus was non- committal in a response. “I can’t say that he gave us any concrete assurances,” Smar said. He said Casey was still considering his vote.

Baucus spokesman Scott Mulhauser didn’t immediately respond to inquiries about the letter and the chairman’s response.

Carried interest is the profit share paid to general partners of the firms, typically 20 percent of a fund’s gains above a set amount. That share is often taxed at the 15 percent capital gains rate; lawmakers including House Ways and Means Committee Chairman Sander Levin want to more than double the rate by taxing it as ordinary income. The top ordinary income marginal tax rate currently is 35 percent and is scheduled to rise to 39.6 percent next year.

No Carve-Outs

Levin, a Michigan Democrat, said earlier this week that no industries would be carved out of the legislation.

White House budget director Peter Orszag predicted Congress within weeks would approve higher taxes on managers of private equity firms, real estate funds and other investment partnerships. The House has passed the legislation three times; the Senate never has voted on it.

Orszag, speaking yesterday at a conference in New York sponsored by the Reuters news agency, said, “I believe that there will be some legislative changes in carried interest, although the exact parameters are still being negotiated.”

North Dakota Senator Kent Conrad, a member of the finance committee, said today there’s a “very active debate” over the tax proposal, including whether to carve out industries. “There is a growing chance that something with carried interest will be included” in the legislation, he said.

Lobbying Campaign

Affected trade groups, meanwhile, are mounting a lobbying campaign.

Marc Heesen, president of the National Venture Capital Association, a Washington-based trade association, said he and the current and past chairs of the group -- Kate Mitchell of Foster City, California-based Scale Venture Partners and Terry McGuire of Waltham, Massachusetts-based Polaris Venture Partners -- have been on Capitol Hill this week urging changes to reduce the effect on the industry.

Heesen said opponents of the tax increase are trying to minimize the damage because the drive to enact the change by Memorial Day on May 31 has squeezed stakeholders. “A lot of rational arguments have gone out the window,” he said.

He said his group seeks to overcome perceptions in Congress that carried interest is predominantly a break for hedge funds, which lawmakers blame for contributing to the financial meltdown. In reality, most hedge funds trade in short-term positions that don’t qualify for capital gains treatment, Orszag said yesterday.

Blend of Taxes

Heesen said his group is proposing a blend of capital gains and ordinary tax rates for assets held between two and five years. Assets held for longer periods should still qualify for capital gains treatment, he said.

The Real Estate Roundtable, a Washington-based trade group representing partnerships formed to buy commercial real estate, is making similar arguments, Vice President and Counsel David Pearce Jr. said last week.

The real estate group got a boost today when the U.S. Conference of Mayors sent a letter asking Levin and Baucus to abandon the carried interest proposal.

“We urge you to seek an alternative offset to the carried interest tax increase on real estate partnerships,” wrote Tom Cochran, the group’s chief executive. If the measure is enacted, “a developer’s incentive to take on necessary risk associated with real estate development will be greatly diminished,” he said.

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

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