Should Private Equity Fund Managers Be Subsidized? rivate equity funds manage over 1 trillion in assets. The managers of $ these funds are paid generously for their services, with much of their incomes coming in the form of “carried interest.” Carried interest is a specified share (normally 20 percent) of the returns of the investment fund. But, instead of being taxed
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at the 35 percent top individual income tax rate, carried interest paid to these private equity managers is often treated as a longterm capital gain and taxed at a preferred rate of 15 percent. Last fall, the New York University Tax Law Review and the Law Review cosponsored a panel discussion on the tax treatment of the vast compensation received by private equity fund managers. Victor Fleischer, associate professor at the University of Illinois College of Law, is author of an article in the April 2008 issue
of the New York University Law Review that is widely credited with sparking a fierce debate in Washington about reforming the treatment of carried interest. He concluded that private equity firms are “taking [the subsidy] further than Congress initially intended,” with detrimental consequences for both economic efficiency and tax equity. In arguing against the status quo, he was joined on the panel by Mitchell Engler ’90 (LL.M. ’91), visiting professor of law at NYU, and Noël Cunningham (LL.M. ’75), professor of law at NYU and the session’s moderator. The latter two cowrote an article building on Fleischer’s work and advocating a specific approach to reform. Fleischer’s article and ensuing calls for reform have engendered a strong response from the private equity industry. At the panel session, Jon Talisman spoke on the industry’s behalf. Talisman, who was assistant secretary for tax policy in the Clinton administration and is now a lobbyist for private equity firms, argued that the treatment of carried interest follows naturally from the general tax preference for long-term investment returns and that reform proposals would discriminate against private equity relative to other forms of entrepreneurship. Much like the panel itself, Washington is sharply divided on the issue of carried interest. As a new Congress and administration come to town in 2009 looking for ways to raise revenue, carried interest is expected to remain a hot topic, with panel members continuing to play important roles in the debate.
John Samuels (left), with David Tillinghast
An Alternate View of Tax Policy At the 12th annual David R. Tillinghast Lecture on International Taxation, John Samuels (LL.M. ’75), vice president and senior counsel for tax policy and planning at General Electric, argued against conventional wisdom, criticizing the standard U.S. view of international tax policy as aiming to promote worldwide economic welfare. Instead, he said, the goal should be to advance our national economic well-being. In a talk entitled “True North: Charting a Course for U.S. International Tax Policy in the Global Economy,” Samuels—chair of the International Tax Policy Forum, a coalition of 30 U.S. multinationals that sponsors tax research—took on the theory of capital export neutrality. This posits that U.S. firms should face as high a tax rate on outbound investment as on domestic investment; then, companies will pursue the investment with the highest yield. Samuels questioned the notion that U.S. investment overseas is a substitute for domestic investment. He said data suggests that foreign investments are actually complementary to U.S. corporate domestic investments. Given this lack of capital flight, Samuels contended that the U.S. should move to a territorial tax system, taxing entities on domestic income, not foreign income. Doing this, he said, will make the U.S. more competitive.
james hines, richard a. musgrave pro fessor of Law and Economics at the University of Michigan, proposed an innovative new way of thinking about international tax at a discussion of his new paper, “Reconsidering the Taxation of Foreign Income.” Hines argued that U.S. foreign tax policy has been stuck in a political and intellectual rut and that the capital import neutrality, national neutrality and capital export neutrality debate has run its course. The standard 106
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view is that, in order to avoid distortions, foreign business income ought to be taxed at the same rate as domestic income. Since tax rates around the world vary, one of the prevailing goals of the U.S. worldwide system of taxation has been to largely undo these differences. Hines scrutinizes one of the assumptions underlying the traditional debate, that foreign firm activities are not changed by the effects of home-country taxation of foreign income. His key point in the
discussion was that it is incorrect to think about foreign tax policy one investment at a time. Rather, tax policy ought to consider the effect on all investments, since where domestic firms choose to invest may influence investment by foreign firms. Rather than level the playing field, says Hines, home country taxation of foreign business income actually distorts the ownership of business assets—reducing both productivity and aggregate income.
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Another Perspective on the Taxation of U.S. Foreign Income