A Taxing Issue for Hedge Funds
Typical hedge fund fees are 2% of assets managed plus 20% of profits. So, a $1 billion fund with a 20% annual return would receive a fee of $20 million plus carried interest of $40 million, for a total fee of $60 million.
Blinder argues that the full amount should be taxed as regular income, as the invested funds are not those of the fund manager, but rather those of the client. As such, the fund manager is not putting their own funds at risk and should not receive the preferred capital gains treatment. Blinder likens their incentive compensation to an author’s royalties or a golfer’s prize winnings.
A handful of prominent investors have made similar arguments in recent weeks. Warren Buffett, at a recent event, pointed out that he paid only 17.7% effective income tax rate on the $46 million in income he received last year, while his secretary paid an effective rate of 30% on her $60k salary. Buffett argued that the increasing disparity in wealth “hurts the economy by stifling innovation and motivation”.
Taking the opposite tack, Harvard New Keynesian economist Greg Mankiw argues that capital gains of 15% are paid on top of corporate income taxes which have been paid at a rate of 35%. Mankiw also questions how Buffett’s income was only $46 million in 2006, barely 0.1% of his assets of $50 billion. In this case, Mankiw points out, Buffett is not taking capital gains on the bulk of his (Berkshire Hathaway) assets, so a change in the capital gains rate would have little impact on his tax rate.
Meanwhile, in his August Investment Outlook, PIMCO bond maven Bill Gross takes a somewhat jaded look at disparities between the haves and have nots and the impact of the tax code.
Wealth has always gravitated towards those that take risk with other people’s money but especially so when taxes are low.
Asking when enough is enough, Gross questions the argument whether hedge fund managers will be properly incented if their tax rates go up, citing with scorn Citadel Investment Group head Kenneth Griffin, who indicated that if tax rates were to increase “as a matter of principal I would not be working this hard”. Of course, a higher rate would certainly impact Mr. Griffin, who earned $1 billion in 2006.
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