House Proposal Would Raise Taxes on Private Equity Income

The investment profits generated by private equity, long a subject of debate in Washington, would be taxed at a higher rate under a proposal on Wednesday by the chairman of the House Ways and Means Committee.

The proposal, part of a broad tax overhaul by Representative Dave Camp, a Michigan Republican, is already being criticized by the top lobbyist for the private equity industry, who says it is unfair. Senator Mitch McConnell of Kentucky, the Senate minority leader, said the overhaul had no chance of becoming law.

Nevertheless, it represents the latest effort to change a tax policy that has been assailed by a number of lawmakers over the past decade and singled out for criticism by President Obama. Private equity investment profits, known as carried interest, are currently taxed as capital gains, at a significantly lower rate than ordinary income.

Mr. Camp seeks to raise the tax on carried interest to 35 percent from the current 23.8 percent rate for the highest earners. Underpinning that higher rate is a proposal that carried interest be treated as ordinary income, an idea that is popular among critics of the current tax policy.

While Mr. Camp’s plan would lower the top income tax rate to 25 percent from 39.6 percent, it would also add a 10 percentage point tax surcharge for carried interest, creating a 35 percent tax rate for the millions of dollars in such income that private equity executives take home.

According to the congressional Joint Committee on Taxation, the carried interest plan would generate $3.1 billion in revenue this year through 2023.

Critics of the current policy argue that private equity deal makers make their money from active management of their portfolio companies, rather than passive investment. These critics also point out that carried interest profits are not proportional to the relatively small amount of capital that the managers invest in a given deal.

“A partnership (e.g., private equity fund) that is in the business of raising capital, investing in other businesses, developing such businesses, and ultimately selling them, is in the trade or business of selling businesses,” an official summary of the proposed legislation reads.

“For the tax law to be applied consistently, the profits derived by such an investment partnership and paid to its managing partners through management fees and a profits interest in the partnership (generally referred to as a carried interest), should be treated as ordinary income,” it continues.

Exempted from the proposed higher rate would be any gains on an individual’s invested capital. The proposed rate would also not apply to real estate development.

Defenders of the current system say the capital gains rate makes sense for carried interest because of the risk involved in private equity deals. The industry’s lobbying group, the Private Equity Growth Capital Council, called Mr. Camp’s proposal “disappointing.”

“Chairman Camp’s proposal penalizes long-term capital investment, which he and other members of the House Ways and Means Committee have purported to support,” Steve Judge, the president and chief executive of the lobbying group, said in a statement. “It is our hope that as the debate over tax reform unfolds, policy makers will utilize the opportunity to reform the tax code as a way to encourage, not undermine, capital investment in America.”

Mr. Camp’s plan â€" which contemplates a cut in the top corporate income tax rate to 25 percent from 35 percent and a reduction of the seven individual tax brackets to two â€" also goes after another corner of Wall Street: the big banks.

Arguing that the Dodd-Frank financial overhaul creates an “implicit subsidy” for the banks deemed systemically important, Mr. Camp’s plan would impose a quarterly excise tax of 0.035 percent on bank assets above $500 billion. (The “subsidy,” the summary of the proposal says, stems from the lower borrowing costs these banks receive from the perception that they are “too big to fail.”)

“While tax reform cannot undo Dodd-Frank, it can and should help recapture a portion of that implicit subsidy,” the summary says. The Joint Committee on Taxation estimates that the bank tax would generate $86.4 billion in revenue this year through 2023.

The plan faces some big hurdles in Congress. Mr. McConnell said it had no chance of passing, and Senator Harry Reid of Nevada, the majority leader, agreed with that assessment.

Private equity executives seem confident that no tax changes are imminent. David M. Rubenstein, a co-founder of the Carlyle Group, said at a conference in Berlin on Wednesday that the departure from the Senate of Max Baucus, the former chairman of the Senate Finance Committee who was recently confirmed as the ambassador to China, lowered the likelihood of substantial changes.

“I don’t think that there will be any tax legislation passed by this Congress at all,” Mr. Rubenstein said.