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The New Yorker

 

The Ferrer Tax

July 17, 2007

By Nicole Gelinas

New York's 2005 Democratic mayoral nominee, Freddy Ferrer, may be politically dormant, but his economy-killing tax philosophy lives on — in Washington, thanks to Senator Clinton and Rep. Charles Rangel.

The former Bronx borough president ran for mayor on a platform of restoring the "transfer" tax on the New York Stock Exchange and other local securities market trades.

New York had wisely repealed this tax back in 1981, but Mr. Ferrer argued that restoring it would generate $1.25 billion for the city annually, money that could be used on the school system.

Most everyone agreed that Mr. Ferrer demonstrated a shocking ignorance of how the financial world — that is, New York's economy — works. Mr. Ferrer's tax could have cost the city more than the $1.25 billion annually in lost income-tax revenue from vanished jobs, and lost property tax revenue from a slowdown in both commercial and residential real estate markets.

Mr. Ferrer was defeated. But some of the Democrats who now control Washington, supported by Mrs. Clinton and Senator Edwards, want to push through a Ferrer-style plan, and on a vastly greater scale. While the bill might not go anywhere soon, particularly since Democratic support is far from unanimous, it's a key indicator of how some of the party's most famous members of Congress would shape domestic policy if they ever got their way.

Last Wednesday, the Senate's finance committee trained its eyes on a relatively new crop of wealth creators — hedge funds and private equity firms — as the next potential big source of federal tax revenue. The committee is considering the merits of a House proposal, sponsored by Rep. Sander Levin, to more than double the tax rate on private equity and hedge fund managers.

Some House Democrats, including the Ways & Means chairman, Manhattan's Mr. Rangel, would like to treat the money the managers earn from their funds' profits — usually 20% of the gains made for investors — as ordinary income, taxed at 35%, instead of as capital gains, taxed at 15% for investments held longer than one year.

The House members don't like this favorable tax treatment. Hedge fund managers, they argue, aren't actually risking their own "capital" to "gain" this money. Instead, those profits are a share of the money outside investors put into the fund. Further, the disparity means that, as Senators Clinton and Edwards argue, middle-class secretaries at hedge funds likely pays a higher tax rate on most of their income than does their boss does on his or her income — and that doesn't seem fair.

But things prove more complicated. First, hedge fund managers get that hefty 20% cut of clients' assets no matter how their funds perform — just as long as they turn a profit — though investors will of course withdraw their money if a fund performs poorly. Because that fixed share of the money comes with a guarantee, at least in the short term, it immediately becomes the manager's money, in reality if not on paper. The lower tax rate encourages the manager to take the greater risk in pursuit of a higher return, because he knows he gets to keep more of that money. Conversely, a higher tax rate on these "gains" will discourage risk taking: nobody wants to risk too much, just to give much of it away to Uncle Sam come April.

But what would a higher tax rate on risk taking mean for the economy? Senator Schumer, for one, unlike Mrs. Clinton, remains agnostic, saying that the tax code should "provide incentives for risk taking and entrepreneurship, because new ideas and new businesses create good jobs." He added that's he's worried that higher taxes on capital could hurt New York's economy, and the nation's. Mr. Schumer is right to worry. New York City, Westchester, and Long Island are home to thousands of hedge fund and private equity fund managers and their employees, and to tens of thousands of people who work indirectly for such industries. New York's major investment houses, public relations firms, and law firms process trades, give advice, handle marketing and customer service, and do other work for hedge funds and private equity funds.

Since 1970, according to a Global Insight study, venture capital firms' investments, just one segment of the private equity world, have helped create more than 10 million American jobs. Companies like Google and Intel got their starts with private equity money. The same week the Senate held its hearing, Goldman Sachs announced that in the first half of 2007, for the first time in history, it had generated less than half of its global revenues from business in the Americas — comprised mostly of America itself. As recently as 2001, the bank earned nearly two-thirds of its revenues at home.

While such news is perhaps inevitable in an economy where national borders matter less to global capital every day, it should serve as a warning to Washington: when taxes on wealth creation are too high, the creators of wealth will take their business elsewhere — and some of the start-up companies in which they invest will follow.

Original Source: http://www.nysun.com/opinion/ferrer-tax-2007-07-17/58519/

 

 
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