Tax Venture Capitalists, Ventures Go Unfunded — Does Reich Understand Incentives?
Robert Reich is advocating a rise in the tax on “carried interest” — the money that venture capitalists (VC) and private equity (PE) partners make after all their investors have been paid. Reich would like to see the tax on carried interest go from its current rate of 15% to the top rate of 35%. Of course, next year, the top rate will be 39.5%, and even higher for higher earners.
In Reich’s world, virtually every investment that a VC or PE firm makes has the Midas touch. They never lose. However, in the real world they do lose, often.
VC and PE partners raise money for their funds. They receive a management fee and a percentage of the funds raised. They are taxed for this effort, as they should be, since they have zero risk associated with this activity. No matter what happens with their investments, they still get paid. Hence, they pay the highest rate of tax, whatever it is.
But once the money is raised, they become bankers and investors. In VC, they make investments in up-and-coming companies on the cutting edge of new industry. Billions of dollars of capital have been invested in Silicon Valley tech firms, biomedical firms, green energy firms, and anywhere there is innovation in the world. If the firms they invest in are successful, the VC makes money by selling them, or taking them to an initial public offering (IPO) on a public exchange.
The investors in the fund are then paid off from the proceeds of the sale. The VC keeps the rest and is taxed at 15% on those gains.
However, nine out of ten of these ventures end in failure. VC is a risky business fraught with danger.
The PE world is much different. They raise funds, just like the VC. Then they invest the funds by purchasing existing, operating companies. They internalize the companies and float a large amount of debt on that company.
The next step is to restructure the company so that it runs more efficiently and can grow quickly — quick growth is necessary to pay off the debt load. As the debt begins to be paid off, the PE firm either sells the company or takes it to an exchange for an IPO. They are taxed at 15% on those gains.
If the firm doesn’t grow, the debt load eats the PE firm alive. It either has to wait longer for a return on investment, or lose. Leverage causes huge profit when the firm is right, but cuts mercilessly when wrong.
Rich people are selfish bastards who’re hogging all the money and must be amde to share by taxation or other government intervention– money just grows on trees to people (academics) like him, just comes into existence somehow, to be distributed (fairly, of course).
My grandfather was taught in college that banks lent money (Back in the 30′s). When they got the money back, they got their original capital plus interest.
Because of this, over time, all the money gradually winds up in bank vaults, and that is why we need high taxes on banks and rich people, to get that money back out of the vaults so it can be given to the people. Otherwise the economy would grind to a halt for lack of money.
He believed this to his dying day. There was no argument I was able to make that would shake him from this belief.
Not that Reich isn’t an idiot, but doesn’t the IRS count losses against gains before calculating the tax?
The way the author writes, you would think that all gains are taxed and all losses just ignored.
The notion is that in order to entice people to put their money at risk, we must allow them a sufficient reward when they win to justify the risk. The greater the risk, the greater the potential payoff has to be. The Reich’s of this world seem to honestly believe that tax levels do not affect individual investment decisions.
Mr. Carter,
I had a much similar discussion with a gentleman on the train just the other day.
When my stop was near and the discussion was nearing its end, he brought up the ever so reliable, ‘..though what about those unable to..’
I parted with the ‘Let’s agree to disagree’ to avoid semantics..
In Reich’s world (where ever that may be) he stated that for every dollar that the fed taxes and spends that dollar will return $1.50. That little equation was presented just before the $878 billion Porklus stimulus package of last year. Therefore if his calculus would work, then the treasure would have seen a $1.3 trillion return on investment. Perhaps the 22% of Americans who still trust congress will give him their money to invest on Wall Street.
If that number were true, then the countries that spent the most would be the healthiest economically.
It’s trivially easy to examine the countries of the world and find out that the exact opposite is true.
Reich is either lying, or he is delusional.
Mark the Great:
I think that we have to call it as heavy on the delusional, both this character and the administration. This appears to be a case of the Ivory Tower Intellects vs Main Street smarts.
I remember when Reich came to visit the Boeing Co in the 90′s while he was Clinton’s Labor Sec. He was escorted around the plant visiting various areas by three or so Boeing managers. A supervisor that I worked with later on was one of Reich’s escorts – each was picked for their knowledge of different areas of the production line. He remarked that this was one of the most aloof people he’d ever had to escort. He never acknowledged any of the facts from escorts – as if the information he was being given were already known by him.
Typical of liberals really I guess. Smug and holier than thou.
Why wouldn’t this little Napoleon (he’s something like 5’5″) who’s never known anything but the public teat advocate milking whatever cow he thinks is appropriate (especially a private one)?
When Reich looks at the private sector and all the money invested in it all he sees is a herd.
@Mark the Great, You are correct that sometimes you can write off losses on companies against other gains. However, the IRS rules vary on this. Truly, the entire tax implications of investing in PE and VC, and Angel Investments are beyond the scope of this article. It depends on how the company is structured (LLC, SUB S etc) and what its capital structure looks like.
But, hopefully you got the point. Taxes matter, and the massive tax increase Mr. Reich is advocating will kill investments of all kinds.
Please listen… the banksters are in bed with progressives all over the world, aided and abetted by intellectual elites such as Reich. They don’t give a damn about debt, about printing money, about bailouts, about increased taxes, about real investment and the cost of capital, or about anything that was once perceived to be standard economic theory. They consider money to be simply a psychological ploy with which to keep the sheeple in line. They don’t think of money as representative of any real value. They will just keep on kicking the economic can down the road forever, in support of their overarching goal of equality via control of everyone’s lives. This is a religion to them, and they are religious zealots that will let nothing get in their way. They will continue to squeeze down on the only source of real productivity in the world, those such as the middle class with their antiquated traditional values of hard work, family, savings, and yes God.
With total control of the productive elements of society, progressives will FORCE you to keep on producing, so that they can take the results and redistribute them to all those deserving types that have had the bootheel of the white man on them for so long. You don’t believe me, do you? It’s not a religion, you scoff. So let me patiently explain… the guiding principle of the progressive secular religion is equality of results in all things, both economically and culturally. Progressives must drag down anything that they deem “unfairly” successful, and elevate that which they view as “oppressed”. Equality of results can only be pursued by treating people, cultures, religions, and societies unequally. In this religion, lies and double standards are not only ok, they are the essence of the whole belief system. In this religion, the Christian God is either renounced completely or made subservient to the State.
The State is the new god, all seeing, all pervasive, all controlling. But until that final victory of the State (coming soon), progressives will falsely spin for you one of their metanarratives and tell you that anything bad now happening is all the fault of capitalists, racists, Wall Street, Republicans, Conservatives, or those evil Tea Party people. Meanwhile, progressives are consolidating the last vestiges of control they have been incrementally, PROGRESSIVELY putting into place since 1913. Do you not believe me? Fine, then don’t. But by the time you wake up some day and realize what I’ve said, it will be far too late to do anything about it.
I am not necessarily disagreeing with you. But answer me this: Most elite progressives are uber wealthy. Given that how come they: a) don’t voluntarily give much of their wealth away to our government; b) ask for a wealth tax so that they can redistribute their wealth to those they seek to help, and c) understand that once wealth is no longer created what will they have to give to the needy?
It seems almost axiomatic to me that the wealthy progressives like Gates, Buffett, Peter Lewis, SKG, Babs, Pelosi,the Kennedys, Kerry/Heinz/Tides, Soros, Goldman Sachs, et al if they really wanted equality of outcome they would give their wealth to the government either voluntarily or via a wealth tax but they do not. So there must be another reason beyond that all progressives lie.
If I am a venture capitalist and the taxes get high enough to bother me I will find a place in the world that is more to my liking. I am tied more to ideas and less to geography. Money is portable.
Yes, money is portable. So is economic destruction in this global economy.
I represent investors in these funds, and a GP is nothing more than an investment manager like a guy running a mutual fund. They get paid very well to manage client funds and to maximize profits for all. However, the argument that their bonus is at risk (and therefore due special treatment) is bogus. The original business construct that led to lower taxation was from an era where the GP contributed sweat equity (no fees) for a split of profits. If they want to stop chraging fees and contribute their labor to the investment enterprise, then they can get a lower tax rate. Take a fee for service and you are no different from a lawyer taking contingentcy fees. The whining is pathetic.
Since your investors are the boss, why don’t they just hire someone who charges less?
I see whining, but it’s coming from you.
No, how about we just target every industry one at a time and crush them with regulation and taxes. They’re all villains, aren’t they?
All the B-school friends I know in Venture Capital are out. They took salary jobs or consulting gigs until Obama is gone and investments are a reasonable risk again (and not subject to government whims). It was the same in the 30′s with FDR – who would expose their savings to FDR’s confiscations?
Oh, sure. We need to make sure that wonderful people like Al “Chainsaw” Dunlap and Jack Welch and the CEO of Goldmann Sachs never, ever pay any tax. Because then they’ll help the rest of us. Just like ol’ “Chainsaw” did by downsizing every company he ever touched to death, making sure he got out with a big profit first. Just like Jack Welch did by firing tens of thousands of loyal employees, then boasting about squeezing “juice” out of workers and then throwing them away. Just like the mortgage lenders did, making loans they knew were hopeless, borrowing on the loans, and getting out with a big profit before the crash they knew full well was coming.
You guys are just suckers, but what makes you worse than most suckers throughout history is that you don’t even have the courage to hate the people who robbed and abused you. No, you love them, you want to make sure they never have to worry about paying taxes. You remind me of Aztec parents, eagerly handing their children to the priests to be sacrificed; you love your disastrous ideology more than you love your own kids, whom you have doomed to life in a third-world America, with a wealth-distribution curve as cruel as that of Haiti or Bolivia.
So long, suckers.
Who’s saying anything about cutting taxes on salaries to zero?
Who’s saying anything about cutting taxes on investment income to zero? (Not that this wouldn’t be a good idea?)
As to Dunlap, Welch, etc, it’s quite obvious that the only thing you know about economics and management is what your union steward told you to believe. You seem to believe that the purpose of a company is to hire you and pay you lots of money. It isn’t, the purpose of a company is to make money for those who own the company. When companies stop making money they do one of two things. They find some way to start making money again, and this is done primarily through reducing costs, or they go out of business.
How many people are employed by bankrupt companies shef?
We are talking about Venture Capital. Dunlap and Welch have nothing to do with this topic.
shef: Hate to break it to you but as I alluded to above, most of the big company CEOs are progressives. Goldman Sachs are run by progressives. Soros, Buffett and Gates are big progressives. Most of Wall Street is owned or at least nominally progressive. So the very people you rail against are the same ones you side with ideologically. Ask them to ask the government to create a wealth tax. Ask them to give 40% of their wealth, annually, to the indigent. See how are you get and see how hypocritical they are. VC is not the villian you think, they are the creators of business.
If you want to starve off all new ideas, inventions, and companies then go ahead and kill the goose that laid the golden (welfare) egg. When we become EU and there is no wealth created then what will you do?
ASKING REICH TO UNDERSTAND ECONOMIC INCENTIVES,IS LIKE ASKING A dwarf TO UNDERSTAND BASKETBALL.
Years ago when it was pointed out to Reich that in all his writings and predictions he was proved wrong. Reich gave a s-e smile and said that least he was consistent. But he belongs to the crew of institutionalist economists like John Kenneth Galbraith. They have consistently been influential in the Democratic Party. The latest book has been James Kenneth Galbraith’s book “The Predator State” in which he recommends wage and price controls, national planning and income redistribution. (What else is new?) Reich signs in approval in the blurbs on the back of the book. That doesn’t surprise. But Nobel prize winner Joseph Stiglitz also approves.
I always wonder why supposedly brilliant people like Krugman and Reich keep coming up with ever more devious ways to raise taxes, as opposed to scheming to make the government more efficient for the betterment of all. Reich even proposed confiscating some of your pension if its balance was over a certain level. What a slug.
@Bernie and BO,
Stiglitz, Krugman and Gailbreath, and by association Reich, do not believe in free markets in the same way that Friedman and the Chicago School of Economics does. Austan Goolsbey, the President’s economic advisor is in with the Reich crowd. They are “salt water economists”. The salt water school’s messiah is Tobin from Yale. They believe markets can be controlled and harnessed-kind of like a puppet. They don’t believe that price necessarily is the whole sum of the game with regard to markets-and that centrally planned structures can be more efficient than random markets.
They are incorrect. Friedman and the “fresh water economists” had it right.
Robert Reich is and always will be a despicable little socialist twerp.
`nuff said
The Castroite/Chavista Left is truly out of control. You’ve got to believe they know how destructive it is to take all the profit out of venture capitalism. They can have only one goal: the naked destruction on Capitalism. What other possible rationalization could they have for almost trebling the taxes on their profits — when only a fraction of their investments make any money at all? (Not that venture capital hasn’t been severely damaged already, as my partners and I know oh-so-well from trying to raise money for an electronics startup.) To quote Dagny Taggart in Atlas Shrugged:
“Have you anything left to loot? If you didn’t see the nature of your policy before–it’s not possible that you don’t see it now. Look around you. All those damned People’s States all over the earth have been existing only on the handouts which you squeezed for them out of this country. But you–you have no place left to sponge on or mooch from. No country on the face of the globe. This was the greatest and last. You’ve drained it. You’ve milked it dry. Of all that irretrievable splendor, I’m only one remnant, the last. What will you do, you and your People’s Globe, after you’ve finished me? What are you hoping for? What do you see ahead–except plain, stark, animal starvation? …Give up!”
[Jim Taggart] looked at her blankly.
“Give up–all of you, you and your Washington friends and your looting planners and the whole of your cannibal philosophy. Give up and get out of the way and let those of us who can, start from scratch out of the ruins.”
“No!” The explosion came, oddly, now; it was the scream of a man who would die rather than betray his idea, and it came from a man who had spent his life evading the existence of ideas, acting with the expediency of a criminal….
Sound familiar?
http://robbservations.blogspot.com/2010/05/stake-in-heart-of-living-beings.html