A Democratic proposal to raise taxes on the private partnerships that are behind buyout mania on Wall Street has a good chance of passing because legislators plan to couple it with an extension of Alternative Minimum Tax relief — a combination President Bush would have a hard time vetoing.
The higher taxes would be imposed on private equity and hedge funds — and possibly real estate and other private partnerships — to generate as much as $80 billion in revenues that could pay for two years of relief from the Alternative Minimum Tax, or AMT, investment analysts estimate.
AMT relief under Republican-led Congresses was extended only one year at a time, raising the dilemma that a major new tax burden will be imposed next year on as many as 23 million taxpayers with incomes between $75,000 and $500,000. The tax applies to households that make heavy use of certain tax breaks such as tax-exempt bonds and child credits.
Analysts say the tax increase would be so large that it would imperil the economy, not to mention the political careers of legislators who allow it to happen.
House Ways and Means Committee Chairman Charles B. Rangel, New York Democrat, recently revealed his plan to couple the minimum-tax relief with a doubling of the tax on wealthy financial partnerships through legislation his committee will vote on next month.
“It’s the top priority,” he said, terming it an “inequity in the system” that must be rectified, and predicting it would be so popular in Congress that it might pass with a veto-proof margin. The Senate Finance Committee is also eyeing the proposal, where it was endorsed by ranking minority member Sen. Charles E. Grassley, Iowa Republican.
The measure would need to move quickly through Congress, analysts say, since AMT relief must be passed by the end of September to give the Internal Revenue Service time to create tax forms and carry it out.
Private equity funds announced more than $250 billion of acquisitions on Wall Street this year and enjoy unprecedented profits that are taxed at the capital-gains tax rate of 15 percent, compared with the 35 percent paid by corporations and wealthy individuals. The funds devised complicated procedures for compensating managing partners, specifically to ensure they pay the lowest possible tax rates.
Fund officials say they are well aware that the handsome profits they derive from acquiring company shares and then reselling them at higher prices after restructuring the companies, make them an attractive target for a revenue-hungry Congress.
The administration opposes the tax increase, which it contends would discourage entrepreneurship, but has not threatened a veto.
“We’re very, very hesitant about trying to target one aspect of limited partnerships for fear of the spillover it’ll have in affecting small business growth, and we don’t support that,” President Bush said recently. “Partnerships are an important vehicle to encourage investment and capital flow.”
Democrats are following a pattern of coupling desirable legislation with tax increases on popular targets, such as the wealthy, smokers and offshore corporations. Although President Bush vows to kill a farm bill and a child health care bill that are financed by tax increases, he acquiesced earlier this year to a bill erasing the tax advantages enjoyed by wealthy people who shelter their income through their teenage children. That bill was coupled with an increase in the minimum wage.
“I don’t think President Bush will be able to veto a bill that hurts a few rich people if it’s coupled with AMT relief that helps 23 million people,” said one equity-fund executive who asked to remain anonymous because his firm is officially opposed to the tax.
Sen. Charles E. Schumer, New York Democrat, is so concerned about the possibility of a major hit to financial firms in his state that he insists any tax increase be applied to all partnerships, including politically powerful real estate and farm partnerships. A tax increase limited to financial firms would not be large enough to pay for AMT relief, he pointed out.
One obstacle seems certain before the bill can clear Congress. Sen. Jim DeMint, the South Carolina Republican who led a coalition of conservatives that blocked an immigration bill in the Senate last month, said he will do his best to kill the tax proposal. Mr. DeMint could raise objections that might require a 60-vote majority to overcome, meaning Democrats will need to win Republican converts to pass the bill in the Senate.
“I don’t think anything that bad will go through. We can block that as a minority,” Mr. DeMint said last month at a forum sponsored by Kudlow & Co. and the National Review. But proponents of the tax say Senate Republicans — some of them up for re-election next year — would face the same pressures over expiring AMT relief that could compel Mr. Bush to sign it.
While fund officials privately concede the proposal has a good chance of passing, they oppose it strongly in public and have been lobbied heavily against it while donating generously to the campaigns of both Republicans and Democrats in an effort to head off the congressional effort.
Private equity and hedge funds have been major players on Wall Street for years, by some estimates generating half of all stock trading on a typical day on Wall Street. Hedge funds have gained notoriety recently with their heavy investments in funds that bought subprime mortgage securities and went bust.
Private equity firms came into the public limelight this year through a string of record-breaking buyouts and initial public offerings by two of the largest funds, Fortress Investment Group and Blackstone Group.
Federal Reserve Chairman Ben S. Bernanke testified that higher taxes on such equity partnerships might only serve to drive them overseas to countries that give more favorable treatment to the shadowy firms, though taxes would not diminish their buyout activities in U.S. markets.
Mr. Bernanke also strongly defended the sometimes-hostile takeover activities of the firms, saying they are the “tool” the economy needs to ensure that weak corporate executives are replaced by more competent managers.
But economic rationales can also be found for imposing higher taxes, which would dampen what some economists consider to be undesirable speculative activities by the funds.
Thomson Financial analyst Matt Toole questioned whether the equity funds aren’t fueling a bubble in mergers and acquisitions, comparable to the technology-stock bubble in the late 1990s. He said the easy availability of inexpensive credit, record corporate profits and the undervaluation of many U.S. stocks also fuel the acquisition craze.
In any case, the ebullience of the markets this year, despite the tax threat — and the funds’ continued acquisitions in ever bigger transactions — dampens worries about any damaging effects on the economy.