Private Equity is death for most companies

Democrats in the Senate are now poised to pass a rule that might slightly clip the industry’s wings — a change to the tax code that would force partners in private equity firms, hedge fund managers and venture capitalists to pay a fairer share of taxes on the money they make.

Private equity firms presided over many of the largest retailer bankruptcies in the last decade — among them Toys “R” Us, Sears, RadioShack and Payless ShoeSource — resulting in nearly 600,000 lost jobs, according to a 2019 study by several left-leaning economic policy advocates.

It is unclear even if private equity pays off for the investors — like university endowments, public pension funds and wealthy individuals — who put money into the industry in the hopes of outsize returns. But, it gets worse; not only do private equity partners make money even if their companies blow up, they also get a pretty good deal from the government on what they earn. Private equity funds generally charge their investors two different fees: a management fee of 2 percent of invested assets per year (funds are held for an average of about six years), and a “carried interest” fee that is 20 percent of any investment gains realized in the fund.

In most other industries, the Internal Revenue Service would categorize a fee like carried interest as ordinary income (like how your salary is taxed) rather than a capital gain (like how your stock market winnings are taxed).

Under I.R.S. guidelines, carried interest is taxed as a capital gain, which has a top rate of 20 percent, rather than as income, which has a top rate of nearly 40 percent.

The private equity industry defends its preferential rate by citing “sweat equity” — even if partners don’t put much of their own capital at stake, they are being rewarded for investing their “ideas and energy,” as Steve Klinsky, a former chair of the American Investment Council, put it in a recent article.

Despite widespread opposition, though, the tax break has somehow endured — as Tim Murphy wrote recently in Mother Jones, it has been “the most unkillable bad idea in a town with no shortage of them, a testament to the unstoppable combination of money and inertia.”

Eileen Appelbaum, an expert on the private equity industry who is a co-director of the Center for Economic and Policy Research, a liberal think tank, told me she favored many of the ideas in the Stop Wall Street Looting Act, a bill introduced last year by Senator Elizabeth Warren and several other liberal Democrats.

One of the most important ideas, Appelbaum said, is known as joint liability, which would hold private equity firms responsible for the debt incurred by portfolio companies if the companies go belly up.