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Hedge Funds Say Measure Would Discourage Investment

A move to end tax breaks for wealthy hedge-fund and private-equity managers is sparking a debate about whether the measure will discourage investment--and even hurt the U.S. economy.

The aim of the tax bill, approved Thursday by the House Ways and Means Committee, is to shield some 20 million middle-class Americans from being hit by the dreaded alternative minimum tax, or AMT, this year. But because this temporary "patch" will cost $47 billion in lost revenue in one year alone, the House panel decided to raise money by going after hedge fund and private equity managers.

The bill would eliminate overseas tax shelters for hedge fund managers and more than double the tax rate on so-called carried-interest profits of private equity firm managers.

The measure has prompted criticism, however, that it could discourage investment at a time when the US economy needs it most.

"Less Competitive"

"It would make American businesses less competitive," Karl Rove, President Bush's former deputy chief of staff, told CNBC. The AMC patch and its increase in capital gains taxes "would make American businesses less competitive, it would raise the cost of capital to American businesses, it would make American businesses less attractive to investing."

Hedge fund managers opposed to the plan believe they're being singled out as easy targets as Congress looks to mitigate a wildly unpopular tax.

"The AMT patch is something the Congress should have been fixing years ago but wasn't focused on because no one was bothered by it," said Michael Hirschfeld, a hedge fund attorney at New York-based Dechert. "Nobody wants to raise taxes, so they're looking for an easy target."

Hirschfeld said hedge fund and private managers are losing tax incentives given to those who gain from stocks. He said the disparity could discourage risk, though he anticipated that managers would continue to work diligently for their clients.

He especially objected to the carried-interest provision, which requires that fund managers pay full earned income taxes on investment partnership gains, rather than the 15 percent capital gains rate that others in the partnership pay.

Democrats Push Fix

New York Rep. Charles Rangel and other Democrats who support the tax measure say the AMT has to be fixed, even temporarily, and innovative ways were needed to come up with a solution.

The AMT was implemented in 1970 to make sure wealthy Americans paid at least some tax. But because the tax was never indexed for inflation, it has gradually included those with more modest incomes. This year, when those affected are expected to jump from four million to as many as 25 million, House Democrats decided to come up with the patch.

Supporters of the changes say that well-compensated managers have unfairly benefitted from the tax system for too long and should be the ones to pay for the AMT fix.

"When you're talking about the total amount of compensation they receive they're getting a lot of money, and they're still going to get a lot of money," said Jeff Levin, partner at Holland & Knight's private wealth practice in New York. "In today's environment this is politically popular. Much of this is disguised compensation and should be taxed as compensation, not as capital gains. It's not inappropriate."

The temporary nature of the reform has caused concern, even from those who support providing AMT relief.

"Markup of this legislation accomplishes two things. First, it prevents 20 million Americans from receiving unexpected tax bills next April," Clint Stretch, managing principal for tax policy at Deloitte Tax, said in a statement. "And second, it puts off for yet another year the hard political choices that go with repealing this fundamentally flawed tax."

Others, though, were more critical, fearing that the taxes imposed on private equity and hedge funds would chill venture capital and send the wrong signal about US willingness to compete in the global economy.

"We are concerned ... about the impact some of the revenue offsets in this bill could have on global competitiveness of US companies," said Michael P. Cangemi, president and CEO of the Financial Executives International professional trade group. "Competitiveness is the name of the game in the world economy, and all aspects of corporate tax reform should put US companies on a level playing field with foreign competitors."