Last week, Senator Elizabeth Warren released a proposal that includes several new, discriminatory taxes and regulations designed to stamp out the private equity business model. This proposal is synonymous with socialized medicine and the Green New Deal in its an attempt to impose big government, command and control policies on the US economy.
While Warren claims the bill will “rein in Wall Street,” it would ultimately harm businesses and workers that depend on private investment and the pension funds, charities and other investors that depend on private equity.
The left may not want to admit it, but private equity contributes to the economy through trillions of dollars of investment and millions of jobs. This investment benefits Congressional districts across the country and tens of thousands of American companies.
The proposal has been endorsed by a who’s who of the socialist left including Senator Bernie Sanders (I-Vt.), Senator Kirsten Gillibrand (D-NY), Congressional Progressive Caucus co-chairs Mark Pocan (D-Wis.) and Pramila Jayapal (D-Wash), and Reps. Rashida Tlaib (D-Mich.) and Ayanna Pressley (D-Mass).
First, the proposal calls for a tax increase on carried interest capital gains. As ATR has written on previously (see here, here), increasing taxes on carried interest is bad policy that undermines several long-standing principles of the tax code – the treatment of partnership income and the treatment of capital gains income.
A carried interest tax hike would arbitrarily treat private equity differently from other investments. There is no justification for differential treatment – the investor purchased an asset, grew the asset by making it more economically valuable, and sold the asset at a profit – exactly the same as any other type of investment.
A carried interest tax hike would also raise just $14 billion over ten years according to the Congressional Budget Office, making it useless as a pay-for.
The legislation would also impose a discriminatory limitation on the ability of private equity owned businesses to deduct reasonable amounts of business interest. The Tax Cuts and Jobs Act imposed a reasonable limitation on the ability of businesses to deduct net interest expenses under Section 163(J) of the tax code. Under the law, companies can deduct interest to the extent it is below 30 percent of EBITDA (earnings before interest, tax, depreciation and amortization).
The Warren bill will impose a more stringent standard that limits “excessive debt obligations” from being tax deductible by companies owned by private funds. In addition to being a discriminatory standard which goes after one type of business practice, the restrictive approach would harm business investment and economic growth.
The proposal also imposes a 100 percent tax on fees paid to investment firms from portfolio owned businesses.
Fund managers currently charge fees to portfolio companies for their services. However, these fees are often used to offset management fees paid from investors to funds. This means that a tax on these fees will likely be passed on in the form of higher fees on investors.
In addition to tax increases, the proposal includes a number of burdensome new regulations. These regulations impose excessive transparency requirements and unnecessary restrictions on worker compensation.
Private equity advisers already have fiduciary duty to act in the best interests of their clients. Moreover, private equity firms are already heavily regulated under several laws, including the Investment Advisers Act of 1940.
It is also important to note that private equity firms are not guaranteed to receive large payouts — a fact that this legislation routinely ignores.
When it comes down to it, Warren’s proposed regulations and taxes will not leave the economy better off. While she attempts to portray private equity as a scourge on the economy, these firms have a role in investing, creating jobs, and lifting wages.
This proposal will instead threaten the ability of the industry to generate returns that flow through to pension plans, charities, and investors across the country.