Private Equity Tax Hike May Drive Capital Overseas, Analysts Fear

Josh Lerner, a professor at the Harvard Business School, told CNBC’s “Morning Call” that increasing taxes on private equity sounds like a good idea, but is unlikely to work in practice.

“On the one hand, there is a very strong equity argument,” Lerner said Wednesday. “Essentially, these are very wealthy people and it’s unclear why they should be paying lower marginal rates than everyone else."

"But there are also a lot of practicalities: I think it’s natural to worry that a) The tax won’t work and b) Even if it does work, there will be a lot of collateral damage to the economy as a whole. So, great in theory, but I think it’s unlikely to work in practice.”

Lerner said increasing taxes on private equity could have several unintended consequences.

“The big worry is that if we impose this tax, it’s likely that the carried interest will no longer stay at 20%,” Lerner said. “Groups will raise 25% or 30%. That will depress interest on the part of pension funds, endowments and others investing in private equity, and we’ll have less private equity as a result.”

Lee Sheppard, contributing editor for Tax Notes, said it made sense to boost taxes on private equity.

“Clearly what the managers are getting is compensation for services,” Sheppard said. “The services they happen to be performing are trying to earn capital gains for other people, but that doesn’t mean there’s anything special about the services themselves. We tax other people’s services income as ordinary income, and that doesn't seem to stop them from working and trying to make more money.”

Morris Reid, managing director at Westin Rinehart, said it’s bad policy and bad politics to raise taxes on private equity.

“I think the time is bad for the Democrats to even be contemplating it -- during this critical presidential cycle,” Reid said. “I think we should be well aware that New York is already losing ground to foreign markets like London because of Sarbanes-Oxley. This scares me and I think it’s going to scare a lot of people."