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How Much For a Tax Break?

September 7, 2007 - by Donny Shaw

If you’re into federal tax policy, there’s hardly been a better time to tune into the hearings taking place in the tax-writing committees of Congress. Several major revisions to the tax code have been introduced into Congress this session, and the goal of this week’s hearings has been to discuss combining two of the most famous proposals — a roll back of the alternative minimum tax and a rewrite of the rules as they apply to investment fund managers — into one enormous bill. Exhilarating stuff for sure. But what may be even more compelling, particularly for those of us who aren’t necessarily fetishists of the tax code, is the elusive and underlying story of how policy is decided when it has a direct downward impact on an industry that has given incredible amounts of money to the party determining the policy.

As Ellen Miller of the Sunlight Foundation writes, “a story about an upcoming legislative battle that doesn’t mention the power of money and its influence is something like writing a novel without describing the scenery.” Before taking a closer look at the scenery, here’s an aerial view provided by the Center for Responsive Politics’ OpenSecrets.org:

Hedge Fund Contribution Trends

OpenSecrets’ data goes more in depth. For instance, you can see the top 20 congressional recipients of campaign contributions from hedge funds in the last election cycle. Topping that list is Independent Senator Joe Lieberman (CT). Senator Max Baucus (D-MT), who introduced the original bill to tax hedge fund managers at a higher rate, ranks sixth on the list. His co-sponsor for that bill, Chuck Grassley (R-NE) isn’t in the top 20. It’s hard to detect a trend as to how the top recipients relate to the hedge fund part of the bill. But between and among the ideas that have been floated, it’s possible to get a sense of the situations that could possibly come into play.

Take, for example, this theory of a good-cop/bad-cop Congress from the Wall Street Journal:

>Being a shrewd bunch, the private equity industry presumably has gotten the message: When vast new fountains of wealth open up in the economy, Congress must receive its ransom in campaign donations. Delivering the wagged finger were none other than Max Baucus and Charles Grassley, chairman and ranking member of the Senate Finance Committee, who’ve taken to musing aloud about how the tax code’s treatment of private equity’s lately fabulous profits might be revised. The bipartisan nature of the initiative should reassure readers that there’s no philosophical issue here. It’s purely bidness. You, private equity, have been remiss in your patriotic duty. Cough up.

Under this theory, the bill is designed to fail as long as private equity and hedge fund managers keep paying off Democrats. And Republicans, as exemplified by Grassley, will be left the party that needs to be pumped with money in order not to be tempted to abandon their party’s principles and push for a tax increase. The lede to this New York Times story, entitled In Opposing Tax Plan, Schumer Supports Wall Street Over Party, seems to suggest that for hedge fund managers, paying up keeps a senator’s hands off your income.

>June was a busy month for Senator Charles E. Schumer. On the phone, at large parties and small gatherings around the nation, he raised more than $1 million from the booming private equity and hedge fund industries for the Democratic Senatorial Campaign Committee, of which he is chairman.
>
>But there is another way Mr. Schumer has been busy with hedge fund and private equity managers, an important part of his constituency in New York. He has been reassuring them that he will resist an effort led by members of his own party to single out the industry with a plan that would more than double the taxes on the enormous profits reaped by its executives.

Is it possible that Schumer is directing the industry by setting an example? In the good-cop/bad-cop shakedown scheme, is Schmuer showing the other fund managers what it takes to walk away scot-free? On the other hand, Hillary Clinton (D-NY), the other senator from New York and a presidential candidate, has come out in favor of the tax increase despite being in the top tier of hedge fund recipients for 2008.

Now, I think this is an interesting but overly-simplistic interpretation. Money, although a big player, isn’t the only factor affecting lawmakers’ actions. It’s not unbelievable, for example, for Chuck Grassley, a Republican with a moderate record on tax issues, to side with
Democrats on this one. It’s not at all clear that he’s taking the position he is in order to ask for money. To many, the question of taxing the fees collected by fund managers at the ordinary income rate is a matter of fairness, a concept that stirs up an uncorruptable, pre-utilitarian sense of justice. The “fairness” explanation also fits for why Baucus is apparently supporting the increase despite all the help the industry gives him for his campaign.

Whatever your perspective on this issue, the ensuing debate will likely be an indicator of how powerful money can be in policy making. We’ll be watching closely.

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