Mr. Higher-Tax-on-Carried-Interest Goes to Washington

  • Victor Fleischer’s paper put private-equity pay in crosshairs
  • New role with Senate Finance panel signals Democrats’ plans

He made his name in academia by criticizing a lucrative tax break for private-equity managers. Now Victor Fleischer is taking his anti-loophole thinking to Washington.

Fleischer will serve as a formal adviser to Democrats on the powerful Senate Finance Committee, a perch from which he says he’ll seek ways to close the so-called “carried interest” loophole -- and to curb other tax benefits.

Fleischer’s appointment is the clearest sign yet that some members of Congress want to eliminate the carried-interest break and tax private-equity managers’ income at ordinary rates. It also signals that congressional pushes for a tax overhaul will seek curbs on other special tax advantages as well.

“I will be working on carried interest, but that’s not the only thing, of course,” Fleischer, a professor of corporate tax law at the University of San Diego, said in a telephone interview. “It’s obviously going to go beyond private equity.”

His influence could grow considerably if Democrats win the majority in the Senate in November. Senator Ron Wyden, the Oregon Democrat who hired Fleischer, would take over as the finance panel’s chairman, replacing Republican Senator Orrin Hatch of Utah.

Capital Gains

“Carried interest” is Wall Street jargon for the chunk of profit paid to managers of private equity, real-estate and other funds. It’s typically 20 percent of a fund’s net gain. Some, including Fleischer, argue that the payments are compensation, like wages. Instead, they’re taxed at capital-gains rates -- as low as 23.8 percent. That’s well below the top rate for wages and other ordinary income, which is 39.6 percent. (Fund managers also typically earn an annual 2 percent fee.)

The arcane term blasted into the political mainstream last year, when both Donald Trump, the Republican presidential nominee, and Hillary Clinton, the presumptive Democratic nominee, called for taxing carried interest as ordinary income.

Trump’s memorable phrase, “hedge-fund guys are getting away with murder,” is somewhat off-base when it comes to describing carried interest. That’s because hedge funds tend to liquidate their investments much faster than private-equity funds, and to be eligible for the lowest rate on capital gains, investments must be held for more than a year.

‘Overwhelming Majority’

Despite the heightened interest during the presidential campaign, a spokesman for a private-equity group in Washington said he doesn’t expect any change.

“The overwhelming majority of Republicans in the Senate and the House, along with some Democratic members, support the current and appropriate tax treatment of carried interest,” said James Maloney, vice president of public affairs at the American Investment Council, which lobbies for the private equity industry. “We do not anticipate that to change.”

Fleischer has used Internal Revenue Service data on partnerships, the main organizational structure for private equity and other investment firms, to estimate that taxing carried interest at ordinary rates could raise $180 billion over a decade. That’s about 10 times the estimates made by the U.S. Treasury Department and Congress’s Joint Committee on Taxation.

Bypass Congress

He has argued in papers and his column that President Barack Obama, who has called for ending the carried-interest break, could bypass Congress and do away with it through executive action. Asked if still held that view, Fleischer declined to comment. He added that his Senate role would be “separate from his academic work.”

Once an obscure academic, Fleischer rose to prominence shortly after he published a now-seminal paper in 2008 that criticized the preferential tax treatment of the profits. Written while he was an untenured professor at the University of Illinois School of Law, the paper, “Two and Twenty: Taxing Partnership Profits in Private Equity Funds,” is now the most-read work on the subject, according to the Social Science Research Network, the leading scholarly website for academic papers.

Fleischer said that a draft of his paper circulated on Capitol Hill around the time that Stephen Schwarzman, the billionaire chairman and chief executive officer of the Blackstone Group LP, made headlines with a multimillion-dollar birthday bash in February 2007. The event cast an international spotlight on the wealth generated by private-equity firms. Four months later, Blackstone conducted a $4.1 billion initial public offering that made Schwarzman’s stake in the company worth more than $7 billion and revealed his 2006 compensation: $398.3 million.

Newspaper Column

A native of Buffalo, New York, Fleischer, 44, may be the closest thing the tax world has to a rock star. He writes the weekly “Standard Deduction” column for The New York Times, in which he has called for universities to spend at least 8 percent of their endowments each year and for the IRS to crack down on real-estate investment trusts that operate prisons, casinos and data storage centers while getting preferential tax treatment available to real-estate income. “I won’t be continuing the column,” he said.

His new boss, Wyden, has slammed corporate inversions, in which U.S. companies move their tax addresses and taxable profits overseas. Wyden called last year for ending six corporate tax breaks that involve derivatives, deferred compensation and certain options trades. In June 2015, he introduced a bill to stop hedge fund reinsurers, including one tied to hedge fund billionaire John Paulson, from using offshore entities in Bermuda and elsewhere to avoid U.S. taxes. He wants to limit corporate deductions for interest payments and force U.S. companies to immediately pay taxes on their foreign earnings.

Permanent Breaks

At the same time, Wyden is known for his calls to reduce corporate tax rates to make the U.S., where the 35 percent rate is one of the world’s highest, more competitive with other countries. He joined Hatch and Representative Kevin Brady, the Texas Republican who chairs the tax-writing House Ways and Means Committee, in sponsoring the 2015 “Protecting Americans from Tax Hikes” bill. That legislation extended or made permanent an array of deductions and tax breaks, including research and development credits, and was signed by Obama in December.

Lindsey Held, a spokeswoman for Wyden and the finance panel, declined to specify what issues Fleischer will be working on. He’ll be a co-chief tax counsel to the committee’s Democrats, working in tandem with a current staff member, Tiffany Smith.

“International competition is our overarching goal,” Held said. Hiring Fleischer signals Wyden’s effort to bring “external vision” to a tax overhaul, she said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE