NYT’s DealBook, Stenographer to Private Equity

The private-equity industry is issuing a “dire warning” about the consequences of raising its taxes, the NYT’s DealBook reports.

In other news, BP direly warns that paying for the oil spill will hamper its ability to drill for oil in the Gulf of Mexico.

Seriously, the “dire warning” the Times dutifully parrots has the PE industry “asserting that plans to more than double the effective tax rate for fund managers could reduce private equity investments by $7 billion to $27 billion a year.”

Put on your hip waders, because the bullshit is deep here:

The council warned that this tax increase could cost tens of thousands of jobs, cut the overall value of the nation’s commercial real estate and even cause default rates on commercial mortgages to rise.

See, the logic is that the private-equity industry uses capital to add jobs to the companies it acquires. That’s a good one. The business, at least the leveraged-buyout part of it, is actually all about loading companies up with debt (in part to pay private-equity investors back for their initial investment), gutting the companies’ workforces, and milking the cashflow.

But how does private-equity arrive at its $7 billion to $27 billion a year number in the first place?

The council said its study used two methods to determine the effect of higher tax rates on private equity investments.

Under one method, the study calculated that each percentage point increase in the effective tax rate resulted in a $1.8 billion annual decline in private equity investments, and it said the tax increase passed by the House last month would result in a drop of $27 billion.

In whose tax rate? The point of raising the carried-interest tax rate is to force private-equity, hedge funds, real estate, and other partnerships to pay the same level of taxes the rest of us do on our income. The problem is, they’ve been paying capital-gains rates while playing with other people’s capital. That’s the whole point.

If the partners are investing their own capital, then it should still be taxed at capital-gains rates.

So how would raising rates on carried interest reduce the capital in the private-equity system? The investors who give the partnerships the capital to invest aren’t going to have their taxes raised here. And the partners who invest their own capital aren’t going to have taxes raised on that part of their earnings. So capital should stay constant, no? The only thing I can figure is that the private-equity folks will now be paying more of their income to Uncle Sam and so will have less to invest back in their own accounts.

Poor guys, that same logic works for the rest of us, too.

So why does The New York Times just parrot what the private-equity industry says? Here’s the last four paragraphs:

The council’s study calculated that the House bill would create an effective tax rate of 38.5 percent, including a 3.8 percent self-employment tax, in 2013. With no tax change, it said, the effective tax rate would be 23.8 percent, including the self-employment tax in 2013. That compares with a current total rate of 18.8 percent.

The study asserted that the carried interest tax increase could lead to the loss of 36,600 to 127,800 jobs that might otherwise have been created through private equity investments.

It said that about half of all private equity partnerships were involved in real estate and that these partnerships held more than $4.2 trillion in assets.

The study asserted that higher taxes might reduce the prices that these real estate partnerships were willing to bid on commercial properties and that lower prices might lead to an increase in defaults on commercial mortgages.

What’s up with these one-source stenographies? The New York Times didn’t have ten minutes to call somebody to counter the spin here?

Further Reading:

What About Private Equity? The industry is getting off easy while it destroys companies and jobs.

WSJ Revisits the Carried-Interest Tax

NYT Is Excellent on Private Equity

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.