Will Bush Agree to New Investment Taxes?

As I wrote in my blog yesterday, I think that efforts in Congress to raise the tax rates on private-equity firms that have gone public and on hedge fund managers presage a bolder assault on the current capital-gains-tax rate.

Look for proponents of a higher cap-gain-tax rate to argue that having a different tax on ordinary income and capital gains adds unnecessary complexity to the tax code and is somehow unfair to workers who get the bulk of their compensation through labor rather than investments. (One of several reasons for having a lower cap-gains rate is that it helps offset the effect inflation has on investment income.)

Plus, Democrats will be looking anywhere and everywhere for dough to pay for new spending programs without adding to the deficit. Already, difficulty in doing so is causing them to scale back efforts to eliminate the alternative minimum tax in favor of yet another temporary fix.

But first things first: Will Congress pass new taxes on Wall Street? It might either raise the tax rate from 15 percent to 35 percent on carried interest—the 20 percent cut hedge fund managers take from fund profits—or impose the "Blackstone tax," which would alter the tax status of publicly traded financial services partnerships, or PTPs. Here are a few cogent observations from political analyst Anne Mathias at the Stanford Group:

"1) At this time, odds appear slightly better than 50 percent that a bill changing tax treatment of PTPs from the capital-gains rate to a corporate rate can be enacted...If a bill is passed, this would improve odds for a carried interest bill.

2) It is still a bit too early to tell what the prospects are for the carried interest bill—it is certainly a tempting piece of legislation because it will raise tax dollars for the treasury to offset the cost of other legislation...It will definitely not be passed completely alone. So, its prospects ride to a great extent on the legislation it gets attached to in the end and also on the progress of the PTP bill proposed by Sens. [Max] Baucus and [Chuck] Grassley.

3) We expect that the timing for a financial services PTP bill to clear the committee will be early fall. It then could be attached to other tax legislation—such as a fix for the AMT or an extension of the research and development tax credit. Next steps for the PTP bill would be another Senate Finance Committee hearing to discuss the bill specifically—then another meeting to mark up a final draft and vote to send the bill to the full Senate. The House of Representatives has not specifically discussed financial services PTPs, and we would expect to see a hearing announced on this soon."

Of course, the big question is whether President Bush will veto AMT reform if it also contains new taxes on Wall Street. AMT reform does seem to be more of a Democratic priority than a Republican one, not surprising given that the heaviest concentrations of affected taxpayers live in "blue" states such as New York, California, Illinois, Connecticut, New Jersey, and Maryland.