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US Tax: Private Equity Council Warns on Carried Interest Tax

The Private Equity Council, the industry's lobbying group, took another shot on Tuesday at the proposed increase in taxes on carried interest profits by investment partnerships, asserting that plans to more than double the effective tax rate for fund managers could reduce private equity investments by $7 billion to $27 billion a year.

The council warned that this tax increase could cost tens of thousands of jobs, cut the overall value of the nation's commercial real estate and even cause default rates on commercial mortgages to rise.

The council released a study of private equity investments of all types, including venture capital, buyouts and growth capital, that showed an increase from $723 million in 1980 to $49 billion last year, with a peak of $137.9 billion in 2000.

It said that private equity investments during this period were affected by changes in tax rates in 1986, 1997 and 2003 and that investments declined after tax increases and rose after tax cuts.

The council said its study used two methods to determine the effect of higher tax rates on private equity investments.

Under one method, the study calculated that each percentage point increase in the effective tax rate resulted in a $1.8 billion annual decline in private equity investments, and it said the tax increase passed by the House last month would result in a drop of $27 billion.

Under the second method, the study calculated that each percentage point increase in the marginal tax rate would result in a 1.07 percent decline in private equity investment. Based on the House's tax increase, it said this would reduce investment by $7.7 billion, if applied to last year's investments of $49 billion.

Carried interest compensation paid to private equity and venture capital managers is currently taxed at the capital gains rate of 15 percent. That rate will rise to 20 percent next year when the Bush administration's tax cuts expire.

The House measure would subject 75 percent of carried interest to the regular personal income tax rate, which will rise to 39.6 percent next year, from the current 35 percent.

Earlier Tuesday, Senator Max Baucus of Montana, the Democratic chairman of the Finance Committee, proposed an amendment that would soften the blow slightly, taxing 65 percent of carried interest at the personal income tax rate after 2012.

The council's study calculated that the House bill would create an effective tax rate of 38.5 percent, including a 3.8 percent self-employment tax, in 2013. With no tax change, it said, the effective tax rate would be 23.8 percent, including the self-employment tax in 2013. That compares with a current total rate of 18.8 percent.

The study asserted that the carried interest tax increase could lead to the loss of 36,600 to 127,800 jobs that might otherwise have been created through private equity investments.

It said that about half of all private equity partnerships were involved in real estate and that these partnerships held more than $4.2 trillion in assets.

The study asserted that higher taxes might reduce the prices that these real estate partnerships were willing to bid on commercial properties and that lower prices might lead to an increase in defaults on commercial mortgages.

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