Will changing the private equity rules increase tax paid?

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One of the regular challenges I face is the suggestion that whatever changes to the tax rules are made the rich will never pay tax. Tim Congdon raised it continually (and annoyingly) on Hecklers last week, for example. In a way, everyone who says this reworks the now near legendary comment in tax justice circles made by a chap called Guy Smith who worked for Moore Stephens who said to the Guardian in 2004:

No matter what legislation is in place, the accountants and lawyers will find a way around it. Rules are rules, but rules are meant to be broken.

The latest argument to this effect comes in a paper by a chap called Michael S Knoll who is at the University of Pennsylvania Law School; University of Pennsylvania - Real Estate Department in a paper entitled "The Taxation of Private Equity Carried Interests: Estimating the Revenue Effects of Taxing Profit Interests as Ordinary Income". There's quite a good summary of it (because it's about as dry as its title) on this tax avoidance site (which presence there gives you some idea of the flavour of what's to follow).

Michael Knoll suggests that if private equity partners in the US were taxed at the 35% income tax rate that they should pay on their earnings (for what is what they are) rather than the 15% tax rate they actually pay on capital gains (which they are not) then the additional revenue that might be raised for the US government would be at least $3.2 billion a year, assuming no avoidance behaviour.

It's curious that LowTax.com call this "negligible". I somehow doubt they say that of all government waste - because tax not collected is, of course, the same as money misspent. But in practice they are, anyway, wrong. For a start this sum is 1% of the US tax gap. Given that half of that, at best, will be recoverable this makes the sum material and far from insignificant.

Note however that both Knoll and LowTax.com promote the idea that in practice this tax would not be collected. Knoll argues that the partners in these funds would shift the burden of their tax to others. Those others might be their clients who might have to pay more than the 20% fee they already pay for the services of private equity operators, or the companies they manage, recharged to them as fees for management services. That will in turn be a cost born by the client in due course.

The assumption is extraordinary. Knoll specifically recognises it. He seems to accept in doing so that private equity operators think they have a right to an after tax income and others have a duty to provide it to them if that tax rate changes.

Those others, it should be noted, include pension funds and other mutual investors these days in addition to the more traditionally wealthy. But both Knoll and LowTax.com assume that this exploitation of those unable to respond directly to this abuse will happen. Implicit in that assumption is the belief that those who represent those collective investment vehicles that will be exploited, be they pension funds, other mutual funds or even charities investing their endowments will not protect their client who engages them as investment manager. That is, of course, likely to be true since those investment managers are part of the same financial hierarchy as the private equity operators.

It's precisely this willing acceptance of fiscal and financial abuse that the Tax Justice Network challenges. We believe in the right of the state to tax. We think that this is legitimate. We think taxpayers should comply with the requirements of the states in which they earn their income. But we also oppose measures, whether in legislation or in so called professional practice that shift the burden of tax from those best able to pay it to these less able to do so. And this is why we object to private equity practices.

If private equity really is the right way to manage a business so be it. I won't argue. But if it's a medium for tax abuse or for making the tax system ever more regressive then I will. And so will my colleagues. Because that's an abuse of social justice, and ethical financial practice come to that.