Democrats Split Over Bill Affecting Backers

"People with large amounts of money will gravitate to the people in power," said Rep. Barney Frank (D-Mass.), a co-author of the House bill. (By Kamenko Pajic -- Bloomberg News)
By Jonathan Weisman
Washington Post Staff Writer
Wednesday, November 7, 2007

In early June, as the Senate Finance Committee began examining how a new breed of Wall Street titan could be paying a special low tax rate on executives' salaries, one of the richest of them, hedge fund manager Steven A. Cohen of SAC Capital Advisors, cut the Democratic Senatorial Campaign Committee a check for $28,500.

Just days later, with DSCC Chairman Charles E. Schumer (D-N.Y.) equivocating on legislation to raise taxes on publicly traded equity firms, hedge fund giant James H. Simons, who earned $1.7 billion last year at his Renaissance Technologies LLC, donated another $28,500 to the DSCC.

By late July, Schumer was off the fence -- and on the side of the hedge funds and private-equity firms in opposing the Democratic legislation.

Later this week, Democrats will face more scrutiny over that choice. The House is to vote on a bill to stave off growth of the alternative minimum tax for a year, offer new tax breaks to middle-class homeowners and expand tax rebates for low-income parents -- paid for largely by nearly $50 billion in tax increases on the burgeoning hedge fund and private-equity industries.

The measure has deeply divided Democrats, pitting a rank and file that has railed for years against inequities in the tax code against the party's money men, who are reluctant to bite the hand that has generously fed them. Hanging in the balance is the AMT, enacted in 1969 to ensure that the wealthiest Americans pay at least some taxes. Instead, it has increasingly affected middle-class taxpayers.

"If you're a Democrat and you have to choose between the alternative minimum tax and the hedge fund industry, that's one tough ideological choice," said Viva Hammer, who recently left the Treasury Department's Office of Tax Policy and is now a tax partner at the law firm Crowell & Moring. "It's a choice between your votes and your wallet."

The House is expected to approve the legislation, possibly by a narrow margin, but it faces much more difficult prospects in the Senate.

The legislation would plug two obscure but highly controversial tax loopholes, deftly exploited by an industry that leans heavily Democratic. Private-equity fund managers earn much of their compensation by taking a cut of clients' earnings. It is pay for work, but critics of the arrangement note that it is taxed as capital gains, at 15 percent instead of the 35 percent income tax rate that they would otherwise pay.

Hammer said that about half of all private-equity compensation is taxed that way. About 20 percent of hedge fund compensation also is taxed at 15 percent, a rate lower than the one most secretaries pay.

"It's one thing to allow such generous tax treatment to a small business or perhaps a real estate investment. It's quite another to apply it to a billion-dollar equity fund," said Victor Fleischer, a University of Illinois law professor who has highlighted the issue.

By taxing investment management services as ordinary income, not capital gains, the nonpartisan Joint Committee on Taxation estimates that the Treasury could bring in an additional $26 billion over the next decade.

The second measure in the House bill would shut down fund managers' abilities to shift compensation to offshore tax havens and defer tax payments on that money for years. Closing that loophole would reap the Treasury nearly $23 billion through 2017.

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