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U. of I. professor calls on Congress to close private equity tax loophole

Jan Dennis, Business & Law Editor
217-333-0568; jdennis@illinois.edu

Victor Fleischer
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Photo by Mark Jones
Law professor Victor Fleischer says Congress should act quickly on a Senate bill that would plug a loophole allowing publicly traded private equity firms to avoid paying corporate taxes.

10/18/2007

CHAMPAIGN, Ill. — Congress should act quickly on a Senate bill that would plug a loophole allowing publicly traded private equity firms to avoid paying corporate taxes, says a University of Illinois law professor who testified before House and Senate panels that reviewed the long-overlooked tax disparity. 

Victor Fleischer says the bill, known as the “Blackstone bill” or “PTP” (publicly traded partnership) bill, would stop firms from using a “passive-income” exception that allows them to avoid the corporate tax, costing the U.S. Treasury millions of dollars.

Fleischer landed in the middle of the congressional debate after writing a paper that argues private equity managers are using the “carried interest” loophole to pay capital gains rates of 15 percent on profits that provide most of their compensation instead of the ordinary income tax rate of 35 percent.  In a related paper to be published next year in the Tax Law Review, Fleischer argues that the Blackstone bill should be passed.

“The Blackstone bill isn’t a long-term solution to the carried interest issue,” Fleischer said.  “But it plugs a gaping loophole. It’s important to act quickly to protect the integrity of the corporate tax base.” 

The bill, introduced by Sens. Max Baucus, D-Mont., and Charles Grassley, R-Iowa, would raise the tax rate to 35 percent for publicly traded private equity firms such as Apollo Management, Fortress Investment Group, Oaktree Capital and The Blackstone Group.  

Senate Majority Leader Harry Reid, D-Nev., suggested last week that a broader carried interest bill introduced in the House was not likely to see Senate action this year.  But observers say the narrower Blackstone bill, which affects only publicly traded partnerships, was gaining ground. 

“If Congress doesn’t act this fall, it’ll be that much harder to address in the future as more and more firms adopt the PTP structure just to avoid taxes,” Fleischer said.

Fleischer predicts Congress ultimately will approve the broader measure closing the carried interest tax loophole, raising taxes on private equity firms as well as oil-and-gas and real estate partnerships.

“I think most of the concerns that have been raised by the private equity industry are bogus,” he said. “They suggested that raising taxes on fund managers is going to decrease the returns to pension funds that invest with these firms. The evidence just isn’t there. Any decrease would be such a tiny amount that it isn’t going to make any difference.”

Fleischer says his interest in the loophole rose from his ongoing academic research into the tax treatment of carried interest. 

He presented his findings at academic workshops in March 2006, but says his work went largely unnoticed until a year later, when congressional aides came across the paper and invited him to testify at a Senate Finance Committee roundtable.

Fleischer, who joined the U. of I. this fall after teaching law at the University of Colorado and UCLA, said his first brush with Congress has given him new respect for the ways of Washington. 

“It’s made me more of an optimist about the potential influence of academics on real world policy debates,” Fleischer said. “I’ve found staffers are very willing and eager to listen to what we have to say and there are lots of smart people in Washington who are interested in getting it right. That’s inspiring.”

Editor’s note: Victor Fleischer can be reached at 217-333-1286 or vfleisch@law.uiuc.edu.