Tuesday, March 08, 2016

GREED FILE - How to Protect Wealth, a Primer

"The Patriot:  How Philanthropist David Rubenstein Helped Save a Tax Break Billionaires Love" by Alec MacGillis, ProPublica 3/7/2016


A private equity mogul lauded for his patriotic donations has quietly worked to protect one source of his wealth — the carried-interest loophole.

On Aug. 23, 2011, a magnitude-5.8 earthquake shook the Washington Monument for about 20 seconds, sending tourists on the observation deck down eight hundred and ninety-seven steps.  One of the two strongest quakes ever recorded east of the Rockies, it fractured two dozen of the stone protrusions that hold up the marble slabs at the monument's peak.  That December, Congress appropriated half of the $15 million required to repair the obelisk, saying that the rest would have to be raised from private citizens.

Within weeks, David Rubenstein, the co-founder of the Carlyle Group, a private-equity firm, announced that he would provide the funds.  On June 2, 2013, Rubenstein joined the Secretary of the Interior and the head of the National Park Service to inspect the progress, atop the scaffolding.  In public appearances, he often tells what happened next, in a deadpan manner that he says is joking.  As he recalled last year in a talk at Rensselaer Polytechnic Institute, he decided, while his hosts were looking away, to leave his mark: “I took a pen out and I wrote my initials at the very top.”

Rubenstein, with an estimated net worth of $2.6 billion, is one of the wealthiest people in Washington.  He is an American-history buff, and practices what he calls “patriotic philanthropy,” on behalf of the national heritage.  In 2007, he spent $21.3 million on a 710-year-old copy of the Magna Carta.  He loaned it to the National Archives and, four years later, financed the construction of a new, $13.5 million gallery to house the document.  He has bought two copies of the Emancipation Proclamation, signed by Abraham Lincoln, and loaned one to President Obama, who displayed it for a time in the Oval Office.  He has made substantial gifts to Monticello, to James Madison's estate at Montpelier, to Robert E.  Lee's mansion, to the Iwo Jima Memorial, and, last month, to the Lincoln Memorial.  (Although he has also donated generously to hospitals, universities, and other traditional beneficiaries, more than half of the several hundred million dollars he has given away fits the “patriotic” theme.)

His role as a civic patriarch extends to other projects.  He is the president of the Economic Club of Washington, which brings together the city's business √©lite for discussions with government and financial leaders, and he sits on the boards of the Kennedy Center, the Brookings Institution, and the Smithsonian.  Every few months, he funds a bipartisan dinner salon for senators and representatives at the Library of Congress, where he interviews a prominent presidential historian, such as David McCullough, Ron Chernow, or Doris Kearns Goodwin.

In 1987, after a short career in politics, Rubenstein founded Carlyle, building it around his Washington relationships and those of his partners — “access capitalism,” Michael Lewis called it, in a critical 1993 profile of Rubenstein in The New Republic.  For the most part, Rubenstein has received favorable press coverage, including widespread praise for his charitable work.  In 2012, the Washington Post described him as the “generous repeat benefactor for Washington's endangered national icons,” and the magazine Washingtonian named him a Washingtonian of the Year.  He is a frequent guest on Bloomberg Television and on CNBC.  Last May, on a “60 Minutes” segment titled “All-American,” he said, referring to the Washington Monument, “The government doesn't have the resources it used to have.  We have gigantic budget deficits and large debt.  And I think private citizens now need to pitch in.”

Until recently, relatively little attention had been paid to one source of Rubenstein's wealth, which he has quietly fought to protect, the so-called carried-interest tax loophole.  The tax break has helped private equity become one of the most lucrative sectors of the financial industry.  Since the end of the recession, private equity has reported record profits, and at least eighteen private-equity executives are estimated to be worth $2 billion or more each.  And during the current presidential campaign, with its populist themes, the loophole has become a target among Democrats and Republicans alike.

The notion of “carried interest” derives from the share of profits that twelfth-century ship captains received on the cargo they carried.  It came into its modern usage in the 1920s, in the oil-and-gas industry, and was enshrined in the federal tax code in 1954.  When a group of partners drilled for oil, a few would put up the money and others would invest only their labor, or “sweat equity” — finding land and investors, buying equipment, and so on.  If the partners sold out, the IRS would tax the profits of all the partners at the lower rate for capital gains rather than as ordinary income.

Over time, partnerships in other industries, mainly real estate and venture capital, began taking advantage of the same form of taxation.  Private-equity firms stretched the model to its breaking point.  Their work is essentially a combination of investment banking and management consulting; they are compensated not for building new ventures from scratch, with the risk that entails, but for managing the investments of wealthy individuals and pension funds and other institutional clients.  These funds are pooled, along with borrowed money, to acquire private companies or to take public companies private — before making improvements or cutting costs and selling at a big profit.

Even if no profits are realized, private-equity firms get paid: under the “2 and 20” compensation structure, they receive a two percent fee annually on assets under management, in addition to a 20 percent cut of profits beyond a given benchmark.  The IRS characterizes the managers' cut of the profits as carried interest, taxing it as though it were capital gains made through the sale of a person's own investment.  For most of the past fifteen years, long-term capital gains have been taxed at 15 percent, compared with 35 percent for ordinary income in the top bracket.

One name for the tax break is the “hedge-fund loophole,” but hedge funds benefit much less than private equity does, because their trades tend to be too short-term to qualify for the low capital-gains rate.  At a Credit Suisse forum in Miami, in 2013, Rubenstein said of private equity, “Carried interest is really what the business has historically been about — producing distributions for your investors from good sales and IPOs … and getting 20 percent of the profits for yourself.”  He went on, “That's how we've really grown our business.”

Barack Obama, during his first presidential campaign, pledged to reform the tax on carried interest and, in 2012, went after Mitt Romney for having enjoyed its benefits as the co-founder of Bain Capital.  This year, Bernie Sanders, Hillary Clinton, and Donald Trump have all attacked the loophole, often using hedge-fund managers as the rhetorical target.  As Trump put it in August, “They're paying nothing, and it's ridiculous. …  These are guys that shift paper around and they get lucky.” Jeb Bush, who made a foray into private equity in 2014, also called for closing the loophole during his ill-fated campaign.  Private-equity partners argue that their tax treatment is justified under the tradition of encouraging risky business partnerships and is necessary for their industry to flourish.  So far, the partners have won out; despite the rise of anti-Wall Street sentiment after the 2008 financial collapse, the loophole has withstood every effort at reform.

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