Venture capitalists are our best hope for a cancer cure, energy independence and a solution to global warming.
Without venture capitalists there might be no personal computers, no overnight mail delivery, no genetically engineered drugs, no Web browsers. Venture capitalists raise incomes, tax revenues and living standards for everybody by financing technology and economic efficiency.
But if they think this entitles them to continue paying income tax at rates otherwise available only to people below the poverty line, they are delusional, arrogant or both.
Venture capital is a "small and fragile" ecosystem that would be damaged if its managers got taxed like everybody else, Scale Venture Partners' Kate Mitchell told the Senate Finance Committee last week. "We do not need additional hurdles to continue to attract the best and brightest minds to our asset class."
Such warnings come as Congress threatens to increase taxes on income earned by managers of venture groups, buyout partnerships and other "private equity" investment. The Bush administration is singing right along.
"I don't believe it makes sense to single out one industry," Treasury Secretary Henry M. Paulson Jr. said a couple weeks ago, as reported by Bloomberg News.
I agree. Which is why, at a time of big budget deficits and Gilded Age income inequality, the country should stop singling out private equity managers for tax relief.
Much of the pay these people earn, it turns out, is taxed not as income but at the much-lower rate applying to long-term capital gains. That would be fine if the compensation really was capital gain. It is not.
Private equity managers generally make a fee worth 2 percent of the portfolio, plus an incentive payment, called carried interest, equal to 20 percent of the profits. (As a practical matter it's often less than 20 percent, but you get the idea.)
The 2 percent is taxed as ordinary income, at rates of up to 35 percent. But much of the carried interest is often treated as a capital gain, taxed at 15 percent, even though it's merely a fee for managing other people's money.
True, it's tied to the real capital gains enjoyed by a fund's limited partners, but to be eligible for the 20 percent managers put up none of their own money. No money means there is no capital investment. No capital investment means there is no capital gain. No capital gain means the payments ought to be taxed as ordinary income - at more than twice the rate they are now.
Raising taxes on carried interest was a minor idea until a recent public stock offering by Blackstone Group opened the kimono on private-equity riches.
Blackstone founders Stephen A. Schwarzman and Peter G. Peterson took out more than $2 billion. House Ways and Means Committee Chairman Charles B. Rangel, a Democrat, has introduced a bill to treat carried interest as regular income, and the Senate Finance Committee, spurred by Charles E. Grassley, the ranking Republican, is considering a similar measure.
Private equity folks have various arguments against this.
Carried interest is like capital gains, they say, because it doesn't pay off for a long time and is tied to the vagaries of the market. Yeah, but so are royalties for authors and patent holders and pay from nonqualified stock options. They get taxed as ordinary income.
Raising the tax will propel venture capitalists overseas, hurt innovation and damage U.S. growth, they say. "The game is ours to lose," said Scale Venture Partners' Mitchell.
This is the perennial anti-tax argument, made by any industry about any tax at any rate. At some level it becomes relevant, but it's hard to imagine private equity managers fleeing the country that has the best entrepreneurs, the smartest engineers and the top managers.
Congress should be very careful about balancing the need for revenue with the desire to soak the rich. The top 10 percent of earners already pay more than half of federal taxes. But taxing private equity managers at the same rate as other rich Americans is hardly socialist.
Thank goodness for grownups courageous enough to oppose their natural constituencies and suggest as much.
"It is appropriate - in fact, a responsibility - for this committee to thoroughly examine these carried interest issues and determine if the tax law is operating consistently," said Republican Grassley at last week's hearing.
Robert E. Rubin, former Treasury secretary and chairman of the executive committee of Citigroup, which has numerous private equity clients, said in The New York Times last month that private equity managers are "performing a service, managing people's money in a private equity form, and fees for that service would ordinarily be thought of as ordinary income." Congress, he added, should examine the issue "with great seriousness."
Keep innovating, venture managers. Do your thing, buyout funds. But stop pretending that the tax rules applying to everyone else aren't good enough for you.
jay.hancock@baltsun.com