History does not record whether Grigori Rasputin, the hardy monk whose misguided ideas about statecraft reputedly helped seal the fate of the Romanov empire, believed in transmigration of the human soul. But if he did, we can guess how he would have wanted his spirit to be revived: as a seemingly impossible-to-kill, multibillion-dollar giveaway for private equity that ranks among the most widely derided clauses of the US tax code.
Congressional Democrats promised this week to kill the tax break that allows investment firms and their executives to receive millions of dollars a year while paying a lower rate of tax than rank-and-file employees.
The subsidy has few defenders even inside the gilded circle. Bill Ackman, the hedge fund manager, on Thursday called the handout “an embarrassment”. Michael Bloomberg, a billionaire former investment banker and sometime US presidential hopeful, told an interviewer some years ago that his friends in the private equity industry “think this is such a joke, even they can’t keep a straight face”.
Your correspondent has spent an entertaining evening with one of the policy’s more poker-faced defenders. He traced a lineage between carried interest and medieval Venice, likening private equity performance fees to the share of the cargo that merchant seafarers received as pay for their perilous labour. The American Investment Council, a lobby group, put the point less poetically this week, calling the Democrats’ proposal “a new tax on the private capital that is helping local employers survive and grow”.
Those comparisons are mostly baloney. Unlike ships’ captains who risked everything, managers of even a medium-sized fund receive tens of millions of dollars a year in fixed management fees. When their bets go wrong, clients typically shoulder almost all of the losses, while the bungling investment managers strive to wipe the slate clean by raising a new fund. A 2008 study of hedge fund fees by two Oxford academics found that generous incentive schemes were of little value unless they were accompanied with stinging penalties for underperformance.
Whether or not Wall Street executives deserve their danger money is a less important question than whether taxpayers should pay for it. Instead of cash, private equity executives receive a portion of their pay in the form of rights to participate in their clients’ investment profits. The Internal Revenue Service ruled three decades ago that those earnings be taxed as capital gains, attracting a top tax rate of 20 per cent, far less than the 37 per cent that the best-paid Americans owe on their cash income.
That logic might have appealed to a convoluted thinker like Rasputin. Rather than defend it, investment firms have assumed an air of studied indifference towards the expected demise of their longstanding tax break. Curtis Buser, Carlyle Group chief financial officer, was asked about the Democrats’ proposal on a long-planned conference call on Thursday. “We got people all over the world, subject to all kinds of different tax rates,” he shrugged.
But the tax break has proved as hard to kill as the mad monk himself, who is said to have devoured a platter of cyanide-laced cakes and lived long enough to demand a healthy pour of Madeira wine. Barack Obama promised to finish off the carried interest subsidy during his 2008 presidential campaign, but never followed through. His successor Donald Trump made the same pledge, yet settled for an adjustment that limited the giveaway to investments that were held for at least three years.
Joe Manchin, the conservative Democratic senator, sounded positively gleeful on Thursday as he administered what finally appeared to be a killing blow. “Enough is enough for the one-tenth of 1 per cent of the wealthiest people in the country having an advantage,” he said at a press conference to announce the surprise legislative deal. “It was long overdue to get rid of and you can’t justify it any more.”
But this proposal, too, turns out to be a feint. A close reading shows that investment firms will keep receiving the subsidy on investments that they hold for at least five years. Even that modest change hinges on the support of Kyrsten Sinema, the Democratic senator who has received donations from Wall Street, and was apparently not consulted in advance.
Private equity was little more than a cottage industry when the IRS handed down the 1993 ruling that helped mint the fortunes of a generation of financial billionaires. Since then, Wall Street firms have attained unimaginable scale, employing more than 10mn workers and imposing an investor-friendly economic logic on industries that shape every facet of American life.
Eliminating the carried interest subsidy would hardly touch the investment industry’s awesome power. The Democrats expect to raise $14bn in extra tax revenue over the next decade if their proposal passes. That is less than half the estimated fortune of Blackstone founder Stephen Schwarzman.
Yet abolishing the reviled tax break would be welcome if it marks the breaking of the spell that Wall Street has cast on Washington.