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Democrats Split Over Bill Affecting Backers
Tax Measure Targets Hedge Funds

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.

"Once people get over the hurdle of dealing with something new and controversial, and they look at these hard figures, it's interesting how supportive they become," said Rep. Sander M. Levin (D-Mich.), one of the bill's authors.

But the wealth of the Democrats' target has proven to be a treasure trove for party fundraisers. Hedge funds and investment firms have been pouring money into Washington, contributing $11.8 million in the first nine months of this year to candidates, party committees and leadership political action committees.

That is more than the $11.3 million they gave in all of 2005 and 2006, according to the Center for Responsive Politics. More than two-thirds of that money has gone to Democrats.

Their contributions to congressional candidates, congressional campaign committees and congressional leadership PACs total nearly $4.8 million this year, well over the $3 million given in 2005 and 2006. Eighty-three percent has gone to Democrats, compared with the 53 percent they received in the last election cycle.

Cohen earned $900 million last year, according to the magazine Institutional Investor's Alpha; he lives in a 32,000-square-foot mansion in Greenwich, Conn., with an indoor basketball court and a pool, and he owns some of the finest contemporary art in the nation. If his income breakdown is similar to the industry average, $180 million would have been subject to a capital gains tax of 15 percent, yielding $27 million. That is $36 million less than what he would have paid if the income were taxed as ordinary pay.

In the past two years, Cohen has given the DSCC $55,200, plus $24,450 in campaign contributions to Sen. Joseph I. Lieberman (I-Conn.) and $4,600 to Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.), according to the Center for Responsive Politics. Both senators are undecided on the issue, their spokesmen say.

Simons, in earning $1.7 billion last year, was ranked as Alpha magazine's highest earner for the second year in a row. The former Defense Department code breaker, who has a doctorate in mathematics, personally charges clients 5 percent of the funds they give him, plus 44 percent of the earnings on their investments. That is more than double the industry's standard 2 percent management fee and 20 percent performance fee.

Democrats have spun that into gold of their own, according to the Center for Responsive Politics. Simons has donated $78,500 to the DSCC since 2005, $25,000 to the Democratic Congressional Campaign Committee and $25,000 to the Democratic National Committee. He also has given $10,000 each to the state parties in Michigan, Pennsylvania and Florida; $8,700 to Sen. Hillary Rodham Clinton (D-N.Y.); $6,500 to Dodd since last year; $4,600 to House Speaker Nancy Pelosi (D-Calif.); and $1,000 to Senate Majority Leader Harry M. Reid (D-Nev.), among others.

"People with large amounts of money will gravitate to the people in power," said House Financial Services Committee Chairman Barney Frank (D-Mass.), a co-author of the House bill who has also received contributions from private-equity firms.

House Democratic Conference Chairman Rahm Emanuel (Ill.) agrees. He initially was skeptical of the bill, but last week he helped vote it out of the Ways and Means Committee. Emanuel even wrote the provision blocking offshore tax deferrals, knowing it was a direct challenge to one of his boosters, Citadel Investment Group of Chicago. Kenneth C. Griffin, Citadel's founder, cleared $1.4 billion last year, and he has given $4,000 to Emanuel, along with $63,900 to the DCCC, which Emanuel headed.

But Frank cautioned that the fight has not been easy, especially for Schumer. "Hedge funds are to New York what tobacco has been to North Carolina. People don't like to tax their constituents," he said.

If the bill can clear the House, the issue will move quickly to the Senate, where Republicans -- and some Democrats -- have grumbled that a measure to stave off the AMT, regardless of its cost to the Treasury, need not be paid for by any tax increase, much less the increases in the House bill. Sen. Max Baucus (D-Mont.), chairman of the tax-writing Finance Committee, said he does not think there is enough support to approve a tax increase on hedge fund managers' income.

Reid said last week, however, that the Senate will stick to its pledge to offset the cost of any tax cut, AMT included, and he pointedly said that no tax increase is beyond consideration.

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