In Favor of a Private Equity Income Tax

The Wall Street Journal's editorial page has never met a tax hike it didn't hate, and the proposal that billionaire principals of private equity funds pay income tax on their income is no exception. But if today's leader assailing the proposal is any indication, the tax should come into law without any difficulties. Here's the WSJ's argument against the tax, which implicitly casts itself in opposition to a New York Times leader from early last month:

"Carried interest" is long-term, risk-based investment income derived from future profits. Those profits are anything but a sure thing...
Doubling the tax rate on public equity will hurt them for sure, but the lower after-tax returns will undoubtedly mean fewer deals, which will do collateral damage to investors and entrepreneurs who depend on this capital for financial sustenance...
The biggest losers from a private equity tax hike may be pension funds, which have become large investors in these funds; their high performance has made millions of Americans wealthier in their retirement. The California public employee pension system is thought to be one of the largest private equity investors in the country.

Let's take these one at a time.

First, "carried interest" is not "derived from future profits", it's derived from past profits. Which are, very much, a sure thing.

Second, increasing the tax rate on private-equity principals will not lower the after-tax returns for investors in private-equity funds. No one is proposing changing the rate at which those investors are being taxed.

Third, increasing the tax rate on private-equity principals will not "undoubtedly mean fewer deals". They will still be raising the same amount of money, which means the total number of deals will remain the same. The only difference will be in the after-tax income of the principals, which will undoubtedly remain stratospheric.

Finally, the pension funds and other investors in private-equity funds have no dog in this race. They get the same returns no matter what. In fact, insofar as the tax hike increases the amount of money that the government has to give to public employees, their stakeholders come out better from the proposal.

If Congress can come up with a bill where private-equity principals pay income tax on all of their income, especially if that bill doesn't hit other partnerships, then it should sail through the legislature.