From Financial Week, September 24, 2007
Looks like pension funds aren’t going to be carrying the ball for private equity firms on carried interest. Rather, they are remaining on the sidelines while private equity firms tell members of Congress that taxing carried interest as ordinary income instead of capital gains would hurt pension funds, which might suffer reduced returns or higher fees, or both.
Pension funds have shrugged off both negative possibilities and have refused to oppose either of the two anti-private equity tax bills now before Congress. One bill, from Rep. Sander Levin (D-Mich.), the No. 3 Democrat on the House Ways and Means Committee, would tax carried interest at the ordinary, individual rate—generally 35%—on profits in excess of what a firm member invests in a venture.
The Senate bill is sponsored by Max Baucus (D-Mont.) and Charles Grassley (R-Iowa), chairman and ranking Republican, respectively, on the Senate Finance Committee. That bill only affects private equity companies that go public, à la Blackstone, and then denies to them some advantages in the tax code that typically accrue to public companies.
The Private Equity Council, the industry lobby, has argued that the Levin bill would constitute a 130% tax increase on private equity funds, real estate partnerships, venture capital funds, and other investors. At House Ways and Means hearings on Sept. 6, Bruce Rosenblum, managing director of the Carlyle Group and chairman of the Private Equity Council, said, “PE sponsors may look at ways to offset the higher tax burden through changes in economic terms that will adversely impact their limited partners. A likely result would be the eventual reduction in the returns of pension funds, endowments, foundations, and other investors.”
This possibility, first raised by Mr. Rosenblum in late July in an appearance before the Senate Finance Committee, initially threw a major scare into the pension industry. The National Conference on Public Employee Retirement Systems sent a letter to Messrs. Baucus and Grassley on Aug. 24 saying the Levin and Baucus bills “could potentially have a negative impact on public pension plans.”
Then, in an unusual move earlier this month, the NCPERS sent a follow-up letter saying its Aug. 24 missive did not reflect the views of the majority of its members, who believe the Levin and Baucus bills will have no effect on pension plans.
At Senate Finance hearings on Sept. 6, the same day Mr. Rosenblum repeated his warning to Ways and Means, two pension experts poked even more holes in the Carylye guru’s scenario. Alan J. Auerbach, director of the Burch Center for Tax Policy and Public Finance at the University of California at Berkeley, stated that if half the tax increase on private equity partners were shifted to pension funds in the form of higher fees, it would translate into “at most around two basis points in the annual return on these pension funds’ assets, and quite possibly much less.”
Mr. Auerbach estimated that corporate defined-benefit and public pension funds have about 13.5% of their assets with private equity companies worldwide, meaning their holdings of U.S. private equity investments is “likely substantially lower.”
Russell Read, chief investment officer of the $248 billion California Public Employees’ Retirement System (Calpers), emphasized that he was not worried about higher fees from top private equity firms because those firms have done very well for Calpers, which only has 7.1% of its assets with private equity funds anyway. The Calpers PE portfolio has beaten its benchmarks year after year, and has returned 14% annually since inception in 1990 compared with the Calpers’ actuarial rate of 7.75%—the annualized gain on investment required to fund pension obligations. He emphasized that Calpers would continue to invest with “the best private equity funds, not the cheapest.”
Corporate pension plans have been similarly unmoved. The American Benefits Council, which represents many Fortune 500 companies, has taken no position on the Levin or Baucus bills, according to a spokeswoman.
As for chances of passage of either the Levin or Baucus bills, Rep. Charles Rangel (D-N.Y.), chairman of the House Ways and Means Committee, is putting together an omnibus tax bill whose top objective is to eliminate the alternative minimum tax, which would cost the Treasury about $8 billion a year over 10 years. Mr. Rangel needs to find a replacement source for that $8 billion a year, and taxing private equity management fees at 35%—as per the Levin bill—could contribute part of that. One estimate pegs revenue from the Levin bill at $2 billion to $3.2 billion a year. FW
Looks like pension funds aren’t going to be carrying the ball for private equity firms on carried interest. Rather, they are remaining on the sidelines while private equity firms tell members of Congress that taxing carried interest as ordinary income instead of capital gains would hurt pension funds, which might suffer reduced returns or higher fees, or both.
Pension funds have shrugged off both negative possibilities and have refused to oppose either of the two anti-private equity tax bills now before Congress. One bill, from Rep. Sander Levin (D-Mich.), the No. 3 Democrat on the House Ways and Means Committee, would tax carried interest at the ordinary, individual rate—generally 35%—on profits in excess of what a firm member invests in a venture.
The Senate bill is sponsored by Max Baucus (D-Mont.) and Charles Grassley (R-Iowa), chairman and ranking Republican, respectively, on the Senate Finance Committee. That bill only affects private equity companies that go public, à la Blackstone, and then denies to them some advantages in the tax code that typically accrue to public companies.
The Private Equity Council, the industry lobby, has argued that the Levin bill would constitute a 130% tax increase on private equity funds, real estate partnerships, venture capital funds, and other investors. At House Ways and Means hearings on Sept. 6, Bruce Rosenblum, managing director of the Carlyle Group and chairman of the Private Equity Council, said, “PE sponsors may look at ways to offset the higher tax burden through changes in economic terms that will adversely impact their limited partners. A likely result would be the eventual reduction in the returns of pension funds, endowments, foundations, and other investors.”
This possibility, first raised by Mr. Rosenblum in late July in an appearance before the Senate Finance Committee, initially threw a major scare into the pension industry. The National Conference on Public Employee Retirement Systems sent a letter to Messrs. Baucus and Grassley on Aug. 24 saying the Levin and Baucus bills “could potentially have a negative impact on public pension plans.”
Then, in an unusual move earlier this month, the NCPERS sent a follow-up letter saying its Aug. 24 missive did not reflect the views of the majority of its members, who believe the Levin and Baucus bills will have no effect on pension plans.
At Senate Finance hearings on Sept. 6, the same day Mr. Rosenblum repeated his warning to Ways and Means, two pension experts poked even more holes in the Carylye guru’s scenario. Alan J. Auerbach, director of the Burch Center for Tax Policy and Public Finance at the University of California at Berkeley, stated that if half the tax increase on private equity partners were shifted to pension funds in the form of higher fees, it would translate into “at most around two basis points in the annual return on these pension funds’ assets, and quite possibly much less.”
Mr. Auerbach estimated that corporate defined-benefit and public pension funds have about 13.5% of their assets with private equity companies worldwide, meaning their holdings of U.S. private equity investments is “likely substantially lower.”
Russell Read, chief investment officer of the $248 billion California Public Employees’ Retirement System (Calpers), emphasized that he was not worried about higher fees from top private equity firms because those firms have done very well for Calpers, which only has 7.1% of its assets with private equity funds anyway. The Calpers PE portfolio has beaten its benchmarks year after year, and has returned 14% annually since inception in 1990 compared with the Calpers’ actuarial rate of 7.75%—the annualized gain on investment required to fund pension obligations. He emphasized that Calpers would continue to invest with “the best private equity funds, not the cheapest.”
Corporate pension plans have been similarly unmoved. The American Benefits Council, which represents many Fortune 500 companies, has taken no position on the Levin or Baucus bills, according to a spokeswoman.
As for chances of passage of either the Levin or Baucus bills, Rep. Charles Rangel (D-N.Y.), chairman of the House Ways and Means Committee, is putting together an omnibus tax bill whose top objective is to eliminate the alternative minimum tax, which would cost the Treasury about $8 billion a year over 10 years. Mr. Rangel needs to find a replacement source for that $8 billion a year, and taxing private equity management fees at 35%—as per the Levin bill—could contribute part of that. One estimate pegs revenue from the Levin bill at $2 billion to $3.2 billion a year. FW
