Capitol formation

Several months ago, the House Financial Services Committee held an exploratory hearing on private equity to investigate whether it might be furthering income disparity in the US. The hearing attracted a decent-sized crowd, but nothing akin to the horde that flocked to the Senate Finance Committee's first hearing on carried interest taxation in July.

An hour before the hearing was set to begin at 10 am, more than 100 people lined the second floor hallway of the Dirksen Senate Office Building. Most stood against the wall reading financial newspapers, scrolling through BlackBerrys and grumbling about the length of the line. Another group sat on the floor, or in some cases folding chairs, waving signs with the names of people or companies that had paid them to hold a place in line.

When a congressional staffer announced at 9:55 that there would be no overflow room for those unable to obtain a seat, a collective groan went up from the back of the line. And when the same staffer said the hearing would be webcast live, the groan intensified. ?You mean I could have watched this at the office?? one disgruntled man moaned, shuffling toward the elevator.

The man was likely irritated further, upon realizing little came of the three-hour hearing aside from the usual suspects voicing predictable positions.

Inside the room, five witnesses were asked whether carried interest should retain its capital gains treatment and be taxed at 15 percent, or be treated as ordinary income and taxed at as much as 35 percent. The answers were varied: three administration officials seemed resistant to tax code changes, a venture capitalist maintained capital gains tax treatment stimulates the economy, and a law school professor argued in favor of GP tax reform.

Kate Mitchell, managing director at Scale Venture Partners, stressed to the Senate Finance Committee that venture capital differs greatly from private equity and hedge funds. ?We do not rely on leverage, we do not rely on financial engineering, nor do we buy and sell publicly traded securities,? Mitchell said. ?Instead, we help entrepreneurs create new companies and sometimes new industries, with all the jobs and economic growth that come with them.?

Taxing carry as ordinary income would increase the cost of doing business, result in less capital going into venture and creating fewer Googles, eBays and Genentechs, she said. Changes to the current tax laws were cautioned against by Eric Solomon, assistant secretary for tax policy for the US Treasury, Peter Orszag, director of the Congressional Budget Office and Andrew Donohue, director of the Securities and Exchange Commission's investment management division.

?We must be cautious about making significant changes to partnership tax rules that have worked successfully to promote and support entrepreneurship for many decades,? Solomon said. He repeated the same phrase at least four times during the three-hour hearing.

Senators from both political parties ? including John Kerry, Orrin Hatch, Mike Crapo, Jon Kyle, John Ensign and Charles Schumer ? also noted concern. Schumer, a Democrat, said that as a senator from New York, his constituents have been calling him continuously on the carried interest tax issue.

?No matter what we do ultimately about these issues, the United States and New York City must remain the leading country and city in the world for financial services and capital formation,? Schumer said.

Schumer added he was worried one industry might be singled out for tax reform ?simply because people in that line of work are making a lot of money or have their names in the newspapers.?

Hatch, a Republican, said he was ?very loathe to tax partnerships just because the partners make a lot of money? ? particularly given that ?that money is not generally squirreled away in mattresses? but reinvested for the benefit of the economy, he said.

Aside from witness Marc Gergen, a professor at The University of Texas School of Law, the only individuals present who seemed markedly in favor of a change to the tax on carried interest were the committee's chair, Max Baucus, and its ranking Republican member, Chuck Grassley.

?We can't allow the carried interest tail to wag the capital gains dog,? Grassley said during his opening remarks. He stressed, however, that that the committee had yet to come to a decision and will hold further hearings on the matter.

Grassley and Baucus have already introduced legislation that would cause publicly traded partnerships, like Fortress Investment Group and The Blackstone Group, to be taxed as corporations, meaning they would be subject to two levels of taxes as opposed to one.