What do you do with $2 billion a year?

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Reports have been made of the highest earning hedge fund managers in the US in 2006. You don't get into the list unless you're earning US$700 million a year. You top it with US$2 billion.

I readily admit, I don't know the people named in the report. Nothing I'm going to write here is personal. But, the following questions have to be asked:

1. How come anyone is 'worth' this much?
2. If it's true that they are, where does that worth come from?
3. If tax plays a part in creating that 'worth', what is that role?
4. What sort of contribution does a person of such 'worth' owe to the society that gave them the chance to earn such sums?
5. And which society was that, anyway?

These questions can be tackled at all sorts of levels. Given that non one will want to read thesis here, let's tackle them directly and straightforwardly.

1. No one is 'worth' this much. That is apparent. No one can personally make a contribution of this size to any company that undertakes a proper trade that justifies such pay in accordance with the theory of economics. I'll be blunt about that. This level of return is what is called 'supernormal' in economics. The results from a monopoly position, imperfect information in the market, or the exploitation of a short term 'rent' that the market should eliminate by the attraction of additional resources. In this case the first and third aren't true. Hedge funds are not in a monopoly position, and wages aren't being reduced by new market entrants. So option 2 must explain what's going on. It's the every secrecy that surrounds hedge funds that let's them exploit the market and make returns of this sort. I stress: pay of this level is a sign the market is not working, not a sign that it is.

2. So secrecy feeds this. Secrecy that is even inherent, albeit I am sure unconsciously, in the link to which I refer above. These people are all 'located' in the US according to the report I've used. You can be sure that their hedge funds are not. They will be offshore. They will be there for two reasons. First they'll pay a lot less tax; second they won't disclose as much about what they're doing. All of these people might manage funds that are solid and reliable: I hope so. But as Long Term Capital Management proved that secrecy can leave the world's financial system horribly close to financial disaster, and none of these people will pick up the cost if that happens. Ordinary people will. That's the truth of these returns: they're only possible because governments the world over bear the risk that these funds will fail. So why are we paying these managers such an extraordinary rent return for the risks they don't take without requiring a substantial premium in tax by requiring they locate onshore in exchange? I'm baffled by this because put simply the return is a risk free payment which overstates worth, considerably. And that worth is overstated anyway: all hedge funds do is gamble (let's be candid) even if they give it fancy names. And no one ever creating worth out of gambling, whilst in the financial markets it's known that the volatility they create is harmful to the underlying prospects of the companies in whose securities they trade (usually with considerable indifference) and that the mergers they promote rarely add value. So, put nicely, this just adds to the parasitical nature of these returns.

3. What's worse is that tax does contribute significantly to this return. Hedge funds pay little or no tax offshore. That's why they're there. So these people are sitting in the US (or London, or wherever) running operations that they claim are elsewhere to avoid paying tax, which tax free yield is almost certainly fundamental to the exceptional market performance they'll probably claim to offer. But I have a simple question? How are you offshore when you're managed onshore? The whole management structure of the hedge fund industry needs to be subject to concerted, co-ordinated attack by the world's tax authorities. Now there is a job for the OECD if ever I saw one.

4. I guess it's obvious as a result that I think those who earn these 'results' deserve to be paying substantial sums in tax to those societies that provide them with the means to earn these returns. 80% would be fine in such cases. Let's start it on income above 5 million ($, £ or Euro, I don't mind which). No one would complain. But again, cooperation is needed. And this might provide some return for the risk these people create for the rest of us.

5. And where is that due? Well, not offshore. I am honest. I don't really believe hedge funds are run off-shore. Of course, the legal arrangements to make it seem that way exist. But the reality is they are run in the major financial centres. So this tax is due in the US, or London and the few other places where this stuff can really happen.

None of which would stop the harm I think hedge funds are causing. I believe in real entrepreneurial activity. I like seeing wealth created. Gambling does not constitute either activity. So I'd also want hedge funds to be subject to the maximum glare of disclosure and scrutiny too. But paying tax on all dimensions of the business, at high rates to reflect the risk they impose, would help me tolerate their existence. Not much else does.

Thanks to Dennis Howlett for the original link