The Sopranos of Congress

The congressional shakedown of the private equity industry would make Tony Soprano proud.Just as the private equity giant, the Blackstone Group, is set to go public, Senator Baucus of Montana and Senator Grassley of Iowa introduced legislation that would increase the tax rate for most of the income for private equity partnerships to 35% from 15% — a whopping 233%. Because the legislation would reduce shareholder returns, it threatens to dampen investor enthusiasm for the Blackstone offering.The senators’ reason for the tax hike is, ostensibly, to bring the tax rates for private equity partnerships in line with the corporate tax rate. They view the bill as the closing of a 20 year-old “loophole” in the tax code, one that they view is being abused by private equity partnerships now starting to go public. But the 1987 law that established the current tax structure is no loophole.The statute was intended to prevent corporations from becoming partnerships. It established that in order for a publicly-traded partnership to qualify for the lower capital gains rate, it must earn more than 90% of its income from interest, dividends, and capital gains. This is precisely the sort of income stream that private equity typically has.Ironically, private equity partnerships that go public will be increasing their federal tax burden even without the Baucus-Grassley bill as their management fees would be subject to the corporate tax rate. While the annual management fees subject to the 35% rate typically are not nearly as large as the interest-dividends-capital gains income, currently those fees are not subject to corporate tax at all.So to the extent the Baucus-Grassley legislation discourages private equity partnerships from going public, that’s revenue lost to the federal government.But there’s really much more at stake than mere tax revenue — Baucus-Grassley is another example of the sort of blatant abuse of power that passes for “government” in Washington, D.C.Private equity has grown dramatically in the past decade, in no small part thanks to burdensome laws like Sarbanes-Oxley, which force companies to spend millions of dollars on useless accounting certifications and compel chief executive officers to regularly assert and reassert in public filings that they are not felons.But while private equity partnerships have been focused on producing impressive returns for their investors in an era where the stock market is just now recovering from the bursting of the 1990s stock market bubble, the private equity industry has neglected to pay homage to Washington, D.C. — and, apparently, that is a big mistake.As Microsoft learned during the antitrust travails of the 1990s, the politicians in Washington, D.C., want their cut of industry success and if they don’t get it, watch out for regulatory agencies, the Department of Justice, or, as in the case of private equity, Congress.The top 10 private equity firms recently launched a Washington, D.C.-based trade association called the Private Equity Council. But for the time being, it’s too little and too late. A sure sign of its novice status in the corridors of Washington is the fact that despite the significance of the Baucus-Grassley legislation, the council has yet to express its position on the bill. It might offend some politicians if it does.This is a far cry from the likes of veteran lobbying groups like the AARP, which would be roasting members of Congress on spits if they even dared to talk about legislation that might be adverse to AARP members.And private equity has gotten the message from the Beltway bandits.As reported in the Wall Street Journal on June 18, private equity is opening its wallet for the 2008 election cycle. Rudy Giuliani has raised $195,000 from the hedge fund, Elliott Associates, LP; John Edwards has raised $182,000 from Fortress Investment Group; and Mitt Romney has raised about $170,000 from two private equity firms. Senator Clinton also is raising substantial amounts of money from private equity according to the Journal.There is no doubt that private equity will eventually cut some deal with Senators Baucus and Grassley and the other 533 political wise guys on Capitol Hill. The two sides will figure out an accommodation that both can live with and business will continue as usual.But is this how government should be run? What precisely is the difference between the shakedown of private equity by Baucus-Grassley and the shakedown of a small business by the local mob? One answer is that Senators Baucus and Grassley are able to shield their ignominious conduct behind their official public duties — but in the end, a shakedown is a shakedown.For those who lament the end of “The Sopranos” on HBO — don’t sweat it. Just tune in to C-SPAN.Mr. Milloy and Thomas Borelli, who contributed writing to this oped, are portfolio managers with the Free Enterprise Action Fund.

The Sopranos of Congress

The Sopranos of Congress

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