The Big Fiscal Cliff Deal Winners: Hedge Fund And Private Equity Moguls

Date: Thursday, January 3, 2013
Author: Nathan Vardi, Forbes

In 2010 Steve Schwarzman, who runs the private equity and hedge fund behemoth the Blackstone Group, compared efforts to raise taxes on private equity and hedge fund managers with Hitler’s invasion of Poland. Schwarzman ended up apologizing for the inappropriate analogy, but on the morning after the House of Representatives voted for a Senate-passed deal to avert the fiscal cliff, it increasingly looks like hedge fund and private equity managers have won their war in Washington.

The bottom line is that hedge fund and private equity moguls will continue to be taxed relatively lightly after the new fiscal cliff legislation. Carried interest will continue to be taxed as long-term capital gains for hedge fund and private equity managers. The top rate for capital gains has increased to 20% from 15%, but most of the carried-interest benefit has been retained. That means that the rich performance fees hedge fund and private equity managers charge their investors—usually 20% of their investment profits—will continue to get favorable tax treatment.

The survival of the carried-interest tax break created by high-paid lawyers for some of the richest Americans is ironic given that President Barack Obama’s announced goal in the fiscal cliff negotiations was to tax the richest Americans more. Now, there will be some rich lawyers and dentists who are paying higher taxes while the far richer hedge fund and private equity moguls the lawyers and dentists work for will experience less of a tax hit. Nobody will cry for the hip surgeon who is being taxed more, but there are no hip surgeons on the Forbes 400 list of richest Americans. There are, however, 31 hedge fund managers on the Forbes 400, representing 8% of the nation’s wealthiest individuals. There are another dozen or so private equity guys on the list, too.

The hedge fund and private equity victory in Washington is pretty impressive given that these rich industries overwhelmingly supported Mitt Romney, a former private equity mogul himself, in the presidential election. In addition, some prominent rich people, like Warren Buffett and David Tepper, himself one of the most successful hedge fund managers in the nation, have called for getting rid of carried interest.

But hedge fund and private equity rich guys have successfully deflected away repeated attempts to change the way they are taxed on performance fees. They have argued that carried interest is appropriate because the capital has been at risk in their funds; that the political fight over carried interest is not worth it because eliminating it would not pick up much revenue in the big fiscal picture; and that targeting hedge funds and private equity funds and not other industries that apply carried interest, like the politically powerful real estate business, would be unfair. President Obama might still give it another try in his second term, but for now there seems to be little enthusiasm for doing anything about carried interest in Washington.