Investors Bristle at Obama Budget

By Thomas Heath
Washington Post Staff Writer
Friday, February 27, 2009

The Obama administration said yesterday that it would change the way it taxes profits for investment partnerships starting in 2011, touching off a wave of protests from business groups that could see their tax bills more than double.

The change is aimed at carried interest, which allows managers of hedge funds, real estate investment trusts, private-equity firms, medical practices and other partnerships to pay tax rates on their profits that are lower than rates paid by salaried and hourly workers.

Investment partnerships have long maintained the lower rates are crucial to their business model. But some Democratic lawmakers argue that the policy allowed big buyout firms such Blackstone Group, Kohlberg Kravis Roberts and Carlyle Group to avoid paying their fair share of taxes.

With the private and public sectors strapped for revenue, Obama's 2010 budget released yesterday proposes to raise taxes on carried interest from a current rate of 15 percent to more than 39 percent.

The new tax rate, effective in 2011, is projected to bring in $2.7 billion in revenue for 2011 and $4.3 billion in 2012, according to senior Treasury officials who would speak only on background because the new plan has not been finalized.

Investment partnerships generally work this way: They are run by managers who use money from investors to buy and sell buildings, companies and other assets. When the investments are sold, the investors typically take 80 percent of the profits. The managers collect the remaining 20 percent (known as the carried interest).

Under current tax law, both the investors and managers' profits are taxed at the capital gains rate of 15 percent instead of higher rates for regular income tax.

Obama's plan would essentially treat investors who use their own capital to buy and sell businesses differently than the managers of the partnerships. Investors would be taxed at the capital gains rate; managers would be liable for income taxes.

The change comes at a time when profits are down at most firms and financing has become difficult to find. Mark G. Heesen, president of the National Venture Capital Association, said the change in taxation would discourage risk-taking.

"Venture capital investors put up some personal money, and then more importantly we put up our brains just like the entrepreneur does," Heesen said. "We don't just put up money and walk away, and see you in a couple of years. We take an active role in growing these companies."

Heesen said venture capital investors can wait years -- and endure numerous business failures -- waiting for the one home run that earns them millions. The lower tax rate helps cover the failures, he said.

Members of the private-equity world in the past have said a change to carried-interest tax policy would punish real estate partnerships in every community -- and congressional district -- in the United States, and not just Wall Street.

There are more than 2.5 million partnerships in the country, managing $13.6 trillion in assets and generating roughly $450 billion in income, according to the Real Estate Roundtable, which is the industry's lobbying arm. Of that amount, roughly 46 percent are real estate partnerships with $1.3 trillion in investments.

"This is not just a Wall Street issue, this is very much a Main Street issue," said Stephen Renna, president of the National Association of Real Estate Investment Managers.

David Hirschmann, president of the U.S. Chamber of Commerce Center for Capital Markets Competitiveness, said Congress considered raising the carried-interest tax two years ago and targeting only specific businesses such as private equity or hedge funds. But as lawmakers tried to exempt certain industries such as real estate, the revenue projections fell significantly.

And there were philosophical objections.

"The whole history on this is that you are taxing the gain on that capital, whether it's the guy that brought the cash or the guy that brought the know-how," Hirschmann said.

© 2009 The Washington Post Company