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Baucus Says Hedge-Fund Tax Bill Is `Nowhere Close' (Update2)

Date: Monday, May 7, 2007
Author: Ryan J. Donmoyer, Bloomberg

May 7 (Bloomberg) -- Senate Finance Committee Chairman Max Baucus said his panel is ``looking at the general question'' of how hedge funds and private-equity firms are taxed, though Congress is ``nowhere close'' to drafting a bill.

``I'm not close to having legislation, not yet, but I may,'' Baucus, a Montana Democrat, said today at the National Press Club in Washington. ``My view is, first I want the facts. I want to know what's going on here.''

A staff-level review in the congressional tax committees is focusing on several issues, including the ability of fund managers to pay the 15 percent capital-gains rate on a large portion of their pay, Baucus said. Other issues under review include how fund managers use offshore tax havens to defer large amounts of pay and the intention of Blackstone Group LP, the private-equity firm seeking to raise $4 billion in an initial public offering, to avoid the 35 percent corporate tax on most of its income.

``I'm looking at it all,'' Baucus said. He added: ``This is all very preliminary. I'm nowhere close to knowing what we should do and should not do.''

Baucus dismissed published ``allegations'' that his panel is close to drafting legislation or deciding on a policy as ``pure speculation.''

``People need to keep their shirts on here,'' he said. He is considering a number of issues, including the effects of any change on the ability of the U.S. to compete globally, he said.

Meetings With Staff

The staff of the Finance Committee is holding a closed-door meeting today with experts on the subject, including University of Colorado law professor Victor Fleischer, who has written a study of the tax implications of hedge-fund managers' pay.

Fleischer's paper examines so-called carried interest, a common payment structure under which fund managers are paid a management fee of 2 percent of a fund's assets and a 20 percent share of future profits. This structure allows them to effectively pay the 15 percent capital-gains rate on most of their income, rather than the tax rate for salary, which is as high as 35 percent.

``My own personal view is that what fund managers do is something in between ordinary income and investment income,'' Fleischer said in an interview. He said he would advise committee aides to adopt a new policy that imposes a ``blended rate'' on fund managers.

``The different rate between capital gains and ordinary income puts a lot of strain on the code,'' Baucus said.

House Scrutiny

The tax structure of the Blackstone IPO has attracted attention in the House of Representatives.

In a March 22 filing with the U.S. Securities and Exchange Commission, New York-based Blackstone said it would organize as a limited partnership, avoiding the 35 percent corporate tax on most of its income and giving it a competitive advantage over rivals such as Goldman Sachs Group Inc. and Morgan Stanley.

The strategy mimics one adopted by New York-based Fortress Investment Group LLC, a private-equity and hedge-fund manager that went public Feb. 8 and offered investors a similar warning. It hinges on the use of a 1987 exception in the tax code that offers favorable treatment to publicly traded partnerships that earn more than 90 percent of their income from passive investments, including interest, dividends, and capital gains.

Massachusetts Representative Richard Neal, a Democrat who chairs the House Ways and Means Subcommittee on Select Revenue Measures, said last month that he is concerned that Blackstone will secure a built-in tax advantage over its competitors.

`Level Playing Field'

``Our tax code should act as a level playing field for every business,'' Neal said. ``Warning potential investors is an indication that there is some doubt in such a risky strategy. I share that concern.''

Hedge funds and private-equity firms have poured millions of dollars into Democrats' campaign coffers. About two-thirds of campaign donations from employees of the biggest hedge funds and buyout firms last year went to Democrats, Federal Election Commission records show. Last month, records showed that Democratic presidential candidate Barack Obama, an Illinois senator, raised more on Wall Street than fellow Democrat Hillary Clinton or the Republican frontrunner, former New York Mayor Rudy Giuliani.

Obama raised $479,209 from employees at the banks in the first quarter, according to FEC filings. Giuliani collected $473,442. Clinton raised $447,625.

Baucus said he wouldn't be influenced by Wall Street campaign money in his deliberations and would focus on finding the right policies.

``That's not relevant to me,'' he said of the campaign contributions.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net