Investment executives relayed to Congress last week that its proposal to raise the taxes paid by hedge fund and private equity managers could harm the economy and financial markets, according to the Los Angeles Times.“There is no justification” for changing the way managers are taxed,” said Bruce Rosenblum, chairman of the Private Equity Council and managing director of the Carlyle Group, in testimony before the House Ways and Means Committee.

Hedge fund managers have been able to get around a loophole in the tax code, and are able to pay lower tax rates on their income. Mangers typically get 20% of the profits, known as carried interest, and those are taxed at the 15% capital gains rate rather than the ordinary income rate, which can be as high as 35%.

Under a proposed House bill, the mangers’ profits would be taxed at the higher income rate. Senate members are considering a less abrasive move, applying only to private equity firms that go public.

A key issues in the debate is whether hiking the amounts paid by hedge funds and private equity managers would trickle down to retirees and other investors in the form of higher fees or lower returns.

Last week experts said that the effect would be limited. Taxing carried interest as ordinary income could push up fund costs by 0.1% to 0.2% a year, said Alan Auerbach, director of the Center for Tax Policy and Public Finance at UC Berkeley, adding that firms might devise ways to avoid such taxation.

“I’m concerned that at least some of the costs would be passed on to pension fund in investors, though it’s hard to say how much,” he said.

At one point during the meeting, Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, pressed an executive from the California Public Employees’ Retirement System for a clear answer. “If you do not know what the effect will be, it sounds like it would not be very great,” Baucus said.

Russell Read, chief investment office at CalPERS, which has a growing private equity stake recently valued at $17 billion, said the answer was not yet clear. “My personal expectation is that this will be a factor. How large it will be is really difficult to know,” he said.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.

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