The visibility of a tax dodge for hedge fund managers continued to grow this week, as former Treasury secretary Robert Rubin spoke Tuesday at a forum arranged by the Hamilton Project about why hedge fund and private equity managers ought to be taxed at a higher rate. Currently, these managers charge a fee for their investment and money management services and report their fee as a capital gain, making it subject to a tax rate of just 15 percent. Fees are assessed as 20 percent of profits.
Private equity firms, and increasingly hedge funds, operate by using independent investor money to purchase companies, improve them, and then sell them for a profit. The overall investment process, which may take up to seven years, does constitute a capital gain. However, fund managers are performing a management service, not risking their own money, so any capital gains are not really theirs to report.
Rubin argued that the managers are performing a basic service, and "fees for that service would ordinarily be thought of as ordinary income." Income for these wealthy managers, he argued, should be subject to the regular income tax rates of up to 35 percent. Manager income has skyrocketed recently with earnings ranging from $500 million to $2 billion a year. With an already quite low capital gains rate, fund managers are clearly not paying their fair share, and a new plan could bring in additional revenue and create a more progressive tax system. On a related issue, Democrat Max Baucus and Republican Charles Grassley of the Senate Finance Committee proposed on Friday that some private equity firms should be taxed under the corporate tax rate rather than being taxed as partnerships as they currently are. We look forward to hearing more about this proposed legislation.