Private Equity: Why Higher Taxes Mean Higher Returns

The Epicurean Dealmaker has a great argument today for abolishing the favorable tax treatement given to private-equity principals. Let me try to summarize:

• The returns on private equity investments are calculated across all private-equity shops, not only the best ones.
• But it's only the best PE shops – the likes of Blackstone and KKR – which seem to be able to consistently generate outsize returns.
• So the best way to increase private-equity returns would be to cull the younger, smaller shops, leaving only the big, successful ones.
• Many of the principals at younger, smaller shops find their career enticing because of the favorable tax treatment it offers: they essentially pay only 15% income tax.
• So if you raised the tax rate on carried interest, you would discourage underperforming investors from entering the private-equity market, which would be left to the large, long-established players with impressive overall returns.
• Which means that raising taxes on private-equity principals would increase returns in the private-equity industry as a whole!

I'm convinced.