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Sorry, You Can’t Raise Taxes on Big Hedge Funds

The debate over how to tax the income of hedge fund managers often turns on a very simple mistake.

People believe that if we tax “carried interest” as ordinary income, we’d raise the taxes paid by the biggest hedge fund managers.

That’s not going to happen.

Take any of the biggest names in hedge funds . George Soros of Quantum Endowment, or John Paulson of Paulson & Co, or Ray Dalio of Bridgewater, or Steve Cohen of SAC Capital, David Tepper of Appaloosa or Ed Lampert of ESL Partners. It’s a safe bet that none of them would pay a dime more in taxes if we changed the way carried interest is taxed.

How would they avoid the new tax regime? There are plenty of answers involving off-shoring or complicated loan-and-investment schemes.

But the simplest answer is that they’d stop running other people’s money.

Each of the biggest hedge fund managers has enough wealth that they would never, ever need to run money for outsiders. Right now they price their service to their investors at a percentage of assets under management, plus a percentage of the upside, minus taxes that are due.

If you raise the taxes due, you create a friction between what investors are willing to pay and what hedge fund managers are willing to accept. For many of the top hedge fund managers, running other people’s money simply won’t be worth it at the highest tax levels.

Soros has already announced that he’s returning funds to outside investors. If taxes go up on carried interest, expect to hear a lot more of this sort of thing.

The only people who will pay more are the guys you’ve never heard of, the young hedge fund managers who do need outside capital. So the effect of raising taxes on hedge funds will be to leave the wealthiest managers untouched while penalizing the upstarts.

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