After fending off a federal tax hike last year, private equity and hedge funds have been mostly immune from the ongoing carnage on Wall Street. That makes them a bigger target than ever for revenue-hungry politicians and interest groups on the state and local level.
Sure enough, the union-backed Working Families Party and a handful of City Council members have begun pushing a plan to impose the city's 4% unincorporated business tax, or UBT, on the "carried interest" generated by equity and hedge fund investments.
The proposal to raise federal taxes on private equity and hedge funds rested on arguments that carried interest - the high investment profits payable to successful fund managers - shouldn't qualify for favorable tax treatment as capital gains, since the managers rarely put their own money at risk.
The income classification issue is moot when it comes to New York State and City, which imposes the same personal income tax rates on all types of income. Thus, adding the UBT would simply amount to double taxation of fund partners who already pay income taxes on their "carry."
This doesn't deter advocates of the tax hike, however. After all, the city's unique UBT will raise $1.5 billion in fiscal 2008, nearly double the amount collected as recently as seven years ago, by double-taxing the profits of investment banks, law firms, and other professional partnerships, not to mention thousands of small businesses. So, the argument goes, why not force the equity and hedge funds to join in the misery - extracting an estimated $200 million from them in the process? In other words, why not make a bad tax even worse?
One leading advocate of the tax hike for private equity and hedge funds has gone further, likening the city's UBT exclusion for carried interest to outright theft on the part of fund managers. "We're talking about a few dozen people who are basically stealing a couple of hundred million dollars from the city," the executive director of the WFP, Daniel Cantor, told the Sun.
So far, the proposal isn't exactly catching fire. Council Speaker Christine Quinn and Finance Committee Chairman David Weprin haven't yet gone near it, and it seems unlikely that Mayor Bloomberg would embrace such an idea. But with revenues deteriorating, there's no telling how many tax hike proposals will resurface within the next eight months or so. The fund tax, which would apply only in the city but would need state legislative approval first, comes on the heels of the WFP's unsuccessful attempt to persuade state lawmakers to adopt an enormous income tax increase, starting at incomes as low as $250,000, as part of the 2008-2009 budget.
Assembly Democrats instead embraced a more narrowly targeted plan to raise taxes on households on New Yorkers earning more than $1 million. The "millionaire tax" died in Albany last month because it was rejected by Governor Paterson - but is considered likely to reappear soon after the November elections.
Similar arguments are made in favor of both soak-the-rich proposals, starting with the claim that the wealthiest New Yorkers aren't paying their "fair share." The facts show otherwise. In 2007, nearly 40% the state's income tax revenues were paid by the highest-earning 1% of taxpayers - households with incomes above $765,000, a category that surely includes all the private equity and fund managers. State and city revenue projections alike are now deteriorating chiefly due to a drop in incomes among the highest-paid New Yorkers.
A second common approach of tax hike supporters is to minimize the size of the increase. For example, backers of the millionaire tax commonly claimed it would have raised taxes by "less than one percent," when the hike really would have amounted to a 13.5% increase in the tax liability.
On the carried interest UBT, supporters are claiming that it would come to only 2% for most firms when, in fact, it would drive up a fund manager's state and local tax liability by between 29% and 58%, depending on place of residence.
New York's statewide income tax rate is now 6.85%, and the added city tax on residents' incomes brings the combined rate in the five boroughs to 10.5%. Adding the UBT would increase those rates to 10.85% and 13.5% respectively - and surely cause more fund managers to cast longing glances in the direction of Connecticut, where the top rate is 5% and where many hedge funds are already happily settled. Even New Jersey, which raised its top rate to nearly 9%, will begin to look good by comparison.
Carried interest has never been subject to the New York City UBT previously - and its exclusion from the tax was made explicit as part of a 1996 UBT reform enacted by the state Legislature at the recommendation of a high-level working group including city finance officials, industry representatives, and legal experts. As the late Walter Wriston observed, "capital goes where it's wanted and stays where it's well treated." And in today's economy, capital that is mistreated will find it easier to go where it is better treated.
Original Source: http://www.nysun.com/opinion/keep-capital-in-new-york/74803/