The Hedge Fund Class and the French Revolution

Date: Monday, July 30, 2007
Author: Ben Stein, The New York Times

LET’S start with the obvious. Hedge funds have created a terribly wealthy new class. Although the data is overwhelming that the mass of hedge funds have not been outperforming the market after fees, money still pours into them. This has often made their proprietors terribly rich.

Somehow, by some alchemy of brilliant tax lawyers, these people are paying long-term capital gains rates of 15 percent on their compensation (even though much of their pay is tied to trades with holding periods that last seconds). Doctors and lawyers and writers and actors pay about two times that amount.

Then there are the private equity people. They buy and sell companies, usually with other people’s money. They put up a tiny slice of their own capital and multiply it with investments from pension funds, very wealthy families and foreign government investment authorities, and they buy companies. They shake the companies up, cut spending, cut reserves and then resell them to us patsies in the public markets for huge profits. “Rip, strip and flip,” as they say. I am not saying all of them do, but some do.

The private equity people get an immense interest in the profits, vastly outstripping whatever capital they had on the line. This “carried interest,” as they call it, is then taxed at low capital-gains rates. If the private equity companies play their cards right, they use yet another loophole involving amortization of good will to eliminate any tax at all if and when they go public.

Now, all of the above appears to be legal, in that it conforms to laws made by Congress and regulations adopted by the Internal Revenue Service.

So what? The fact that the law is such and such as of July 2007 does not mean that it has to be that way in July 2008 or even in September 2007. The laws of taxation, like all laws, are political. They are not based on commandments from the Lord God Jehovah carried down on tablets from the mountaintop. They are not ordained by Solomon. They are political, hewn from the give-and-take of lobbyists, expert witnesses, law professors, economists and donors.

The law can be changed. Laws are changed all of the time in the tax arena. The oil companies used to get immense tax allowances that they don’t get any more because of political pressures. The tax rate on the last dollars of high-income people used to be above 90 percent. It’s not like that any longer. Why? Political change. It applies to the tax code as well as to all other laws.

Now, let’s think about what’s going on in America right now. We are in a war. We are apparently not winning the war. The military is desperately shy of funds, to the point where our fighting men and women are being shortchanged in training and equipment.

We also need more money for our soldiers’ pay, so their families do not have to live like church mice while their spouses are deployed in Iraq or Afghanistan. In these circumstances, is it fitting and morally right for the richest of the rich to be paying either very low taxes or no tax at all?

Is it right or even admissible in the human conscience that while teachers, emergency room technicians, police and firefighters are taxed at full earned-income rates — and often underpaid — that the highest-earning people in this country should pay at either very low tax rates or none at all?

Or, put it like this: do we dare send our men and women to fight for an America in which the very rich are so favored by the government that it amounts almost to an aristocracy?

Long ago, I had a European history teacher named Mrs. Enright. She explained to me that one of the causes of the French Revolution was the sad truth that the aristocracy was not taxed at all, while the workers and burghers were taxed highly. Is this our future?

Maybe the law does allow for favorable tax treatment for hedge funds if you have good enough lawyers. Maybe the law does allow for private-equity managers to receive capital-gains treatment for what is clearly money management, not risking their own capital.

But the mark of a great society is that its laws approximate morality and fairness. Is this really what we have in the tax code now? If so, fine. If not, why are we not changing it?

(Is it because of the pitifully cheap contributions of the finance industry to the two parties? If so, the politicians are much more pitiful than I had thought. Contributions in the thousands and hundreds of thousands for tax breaks in the billions? This isn’t sensible even on an old Tammany Hall basis. Contribute a penny to get a hundred dollars? What’s up with that?)

AND please, let’s not haul out that old chestnut about having tax incentives to encourage entrepreneurship. We already have enough people who want to be rich (which is another phrase for “entrepreneurship”). What we are lacking is oil and gas. Maybe we should give the oil exploration people lower taxes. What we are lacking is people willing to fight the war on terror.

Why don’t we just have a tax holiday for people who are fighting in Iraq and Afghanistan for five years after they get back? This would be the tax code addressing real shortages, not an imaginary shortage of money mania (oops, I mean “entrepreneurship”).

Let’s keep it real: Congress can take notice of a mammoth inequity in taxation during wartime and make the tax on private equity and hedge funds approximate the treatment of other highly paid people — or it can continue down the road to the Bastille.