Running Away From Steve

Private equity is distancing itself from the symbol of excess

In the escalating fight over how to tax lucrative private equity and hedge funds, both sides have a Stephen Schwarzman strategy. Gleeful backers of the bid to up Uncle Sam's cut of the funds' earnings say the flamboyant, free-spending CEO of private equity giant Blackstone Group symbolizes the excesses and outsize pay of the controversial sector. As for the legion of lobbyists hired by Schwarzman and others to quash a tax hike, they're running from him as fast as they can.

With billions at stake and a populist backlash against private equity brewing, Blackstone and its allies know there's only one way to win this fight: Shift the focus away from Schwarzman. Sources familiar with their strategy say they are amassing a war chest and planning a wide-ranging campaign that will rely on a host of time-tested Washington tactics in hopes of redefining the debate.

They've got their work cut out for them. Just as Congress began eyeing the huge pots of money earned by hedge funds and private equity, tales of Schwarzman's over-the-top 60th-birthday bash, massive initial public offering, and lavish lifestyle hit the headlines. Reaction was swift: Two bills to end what backers say are the funds' unfair tax advantages were quickly introduced.

Typically, such partnerships pay no taxes overall, while their executives pay only a 15% capital-gains tax on profits from trading or dealmaking. The first of the two measures, dubbed "The Blackstone bill," would ensure partnerships that go public pay the 35% corporate tax rate. A second, broader bill would force partners in private equity, hedge funds, and venture capital to start paying individual income tax rates of up to 35% on much of their earnings. Backers argue that ending the discrepancy is simple tax equity. "Stephen Schwarzman pays a lower tax rate than his chef," says one Capitol Hill aide. "How can that be right?"

TALK RADIO

With Schwarzman unlikely to win public sympathy, the first goal of the lobbyists lining up for the fight is to give the funds a better public face. The real victims would be retirees, they claim, since boosting taxes on the earnings of private equity and hedge fund managers will ultimately hurt the returns of their pension fund clients. Americans for Tax Reform has sent an alert to 800 conservative talk-radio hosts, blasting the move with the headline "Democrats Want to Tax Your Pensions." And the conservative Club For Growth aims to raise several million dollars from Wall Street for TV ads in key congressional districts. Such spots could echo the famous "Harry and Louise" campaign that doomed then-First Lady Hillary Clinton's health-care proposal.

Look for the bills' opponents to argue that keeping the status quo is good public policy. In part, that reflects the Republican aversion to tax hikes. Efforts are under way to reframe the debate as a fight between antitax Republicans and liberal Democrats. "It's not the government's money, they didn't earn it, and they should keep their cotton-picking hands off it," says Grover G. Norquist, president of Americans for Tax Reform. Expect arguments that any changes also will force firms offshore, hurting U.S. competitiveness.

Building a broader coalition against the measures is crucial, too. It's easy to demonize private equity kingpins with stratospheric income, but what about your local real estate developer or an entrepreneurial partnership formed to hunt for oil and gas? Many also only pay capital-gains rates. Although the bills don't target those sectors now, Michael Ryan, head of the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness, warns they might. "I don't think anyone should assume they're out of the woods yet," he says.

Will it work? For now the bills have bipartisan support. Add in claims that any money raised—by one estimate, $4 billion to $6 billion from private equity alone—will fund popular goodies like education credits and middle-class tax relief, and proponents believe they'll win. Both sides say the unknown is whether there's enough support in the Senate to pass the bills or to withstand the likely Presidential veto. But if not, few think the issue will die. After 2008, the White House could have a different occupant, and the private equity tax fight could get even hotter.

By Eamon Javers

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