Anyone can be wrong about a person once or twice. I mean really, that is ok, right? Once or twice. So I was wrong about Andrew Ross Sorkin. I originally thought he was an almost charming but mostly harmless, boobish gadfly who didn't really understand finance. I couldn't have been more wrong.
In fact, after reflecting on this carefully, it is now my considered opinion that Sorkin is a dangerous fool who is prone to do some serious damage wandering around carrying a Louisville slugger with nails driven through it while wearing a red bandanna fashioned into a blindfold and swinging wildly at dangling financial issues in the middle of a seven year old's birthday party.
So no surprise, then, that when Percy Walker's blog recently outlined a wonderfully Nixonian "enemies list" that enumerates (quite accurately in my view) the many enemies of private equity (that is the many people who would remove the capital gains treatment from carried interest in private equity, effectively more than a 100% tax hike on the funds in question) Sorkin (who ranks #1 on the list) goes over the deep end. He blows a gasket at Walker and lowers himself (in typical leftist style) to attacking the man, as if credibility in this game was the match point. To wit:
...but when contacted last year by Forbes magazine — which failed to find any mention of Mr. Walker in public documents — the operator of the blog said: 'I lack the desire to establish that I even exist,'"
I suspect that both Sorkin and Forbes missed the essence of the joke that is the fictional Percy Walker. True, it is a little subtle. Hint: your first clue should have been the stock photo of the annoyingly diverse (two minorities on a four person team) office staff- but, given that this must trigger far-left fantasies of utopian workplaces, perhaps the blinding effect explains the sudden mental density on the part of Sorkin and the financial press. Still, it was obvious to the rest of us. But then, no one (that I know) accused Sorkin of having any qualities even remotely resembling a sense of humor.
Interestingly, I had an exchange with Sorkin (who I have actually met in person on at least one occasion) not so long ago where he worried that I was "out to get him." I explained that I was merely "out to get" his anti-market prattle (and it is hard for this not to be a full time job by the way). He seemed unconvinced, but his concern in this regard seemed not to prevent him from asking me out, sight unseen since he could not remember who I was (women, finance, it happens a lot). (I will, by the way, post the logs of this exchange only if Sorkin first denies it occurred). Luckily for me he promised to safeguard my identity if we met. Thank god, imagine if my friends found out I was out on a date with him. Very generous offer, given the circumstances.
You know, on further reflection, I feel that making this change in tax treatment is entirely logical and needed to sustain the economy. We know how desperate the Treasury (subscription required) is for revenue this year.
Sorkin is right behind me on this:
Let’s be honest: it is a charade that private equity firms have claimed their 20 percent performance fees at the lower capital gains rate. To qualify, they invest a nominal amount of their own money to demonstrate that they have put something at risk, but it’s a ruse. They are paying capital gains rates for doing their job, which should be taxed at the regular income rate.
Indeed. We cannot let people take capital gains on profits derived from "other people's money" after all. And I agree with Sorkin. And he is right. The 1% of capital contributed by the general partner on a $1 billion dollar fund is definitely "nominal" in terms of personal wealth. I know Sorkin sneezes in intervals of $10 million. By this standard I think we might need to examine the investments of some of the limited partners too. To the extent they only have a few percent in the game how can their capital be said to be "at risk?" See, because ignoring diversification and betting the ranch on natural gas futures is what we want to encourage. (It makes for great copy when those blow up too, you know).
In fact, while we are at it, there are any number of situations that have a similar stench about them. Closing these criminal loopholes for "the rich" will be an outstanding way to boost revenue for the Treasury and deter the use of leverage in all situations. For that matter, the tax deduction on interest payments in general is a terrible idea. All we have to do is look to any number of the more conservative organized religions (or the Germans) to get a good view on the evils of "Schuld."
Actually, this idea didn't originate with Sorkin. I know. Surprise. It seems to have found traction after a paper written by Victor Fleischer which, in the much more measured fashion of its later drafts, worries after salary that would otherwise have been paid to private equity professionals being pumped back into their funds to enjoy tax deferral and capital gains treatment.
Mr. Fleischer, however, at least has the grace to appear a little embarrassed about the brouhaha he has caused, and it is easy to forgive him if you read the original work, one that has been taken far afield of its original intent by democrats eager to geld private equity in the deluded belief that it will somehow improve the economy (or perhaps just to fleece the productive segments of the economy in the interest of "fairness.")
Fleischer toned down his suggestions, which have more to do with tax deferral and shifting of real income into partnership structures than with the capital gains treatment, I think but am not sure, in response to peer review. Sorkin is quite late to the party here, but then he probably never read the paper in the first place. Obviously he hasn't been reading Going Private carefully, or he would know this as I commented on Fleischer's paper more than a year ago. That doesn't stop him, of course, from flailing about as if he were leading the charge. I suppose that's what financial press do, however.
Mr. Fleischer, by contrast, even had the courage to self-nominate himself for Going Private's Thai Medal, one of the prizes offered in connection with the Going Private Awards. (Nominations are still open).
The Thai Medal
This beautiful, forty eight pound brass and pewter medallion is ribboned for display around the neck of the recipient. Awarded to the individual or organization most responsible for fostering regulatory or legislative initiatives leading to the frustration of efficient markets.
I reproduce his letter (with his permission) below:
On Tue, 20 Mar 2007 19:42:02 -0500 Victor Fleischer wrote:
Dear Equity Private - I hope you are doing well. I hereby self-nominate for the Thai Medal. I actually think changing the tax treatment of carry is good for economic efficiency, altho I gather from your previous blogging that you disagree.
Anyway, here's the most recent version of the paper, which is a bit more moderate than the version you saw before. The paper has reportedly contributed to the stirrings on Capitol Hill.
Don't hate me.
Says Fleischer in another email to me:
Apparently some folks on the Hill are still reading from my March 2006 version, which wasn't as balanced a view as the current version.
Victor Fleischer, dear readers, is a class act, even if he is from California.
Interestingly, Sorkin only manages to credit Mr. Fleischer in passing and then only because he is listed on Walker's "enemies list." Convenient, that.
But let's not shoot the messenger. Despite what he would have you believe was original thought, it's not his idea after all. Let us instead consider the many ways that people earn money with "other people's money." Obviously, all of these should be closed as "loopholes."
I mean really. A home owner puts down a paltry 20% of the purchase price, borrows the rest from big and stupid banks that don't know they are being taken advantage of and then pockets the gain for themselves. Big stupid banks only get the interest rate but when the house is sold all the gain to the homeowner is taxed at capital gains rates. And what does the homeowner have at risk? Hurricane? Insured. Flood? Insured. Fire? Insured. Let's be honest. It is a charade that home owners have claimed the gains on home sales as capital gains. They were only doing their job, servicing interest rates and improving the property. What's worse, if they buy another house they can defer the taxes until their next sale and then defer them again after that one. We have to close this loophole immediately, clearly. No wonder the housing market has been out of control the last ten years. Think of the revenue to the Treasury too. That's always a priority for market actors.
This is exactly the same thing. Someone else's money (the stupid finance company) being used to make money for the car owner. Not only do they get the use of the car, but if they profit from it at the end, well, you can see where I am going. We need to close this loophole. Anything this car trades for or sells for over the Blue Book value should be taxed at double ordinary income rates.
Margin Purchases of Stock
Again, traders are ripping off the brokerages by borrowing someone else's money to make a profit. How can we allow this to be taxed favorably? I don't care if you held that stock for 4 years and paid margin on it the entire time. This should be taxed at ordinary income rates. We'd hate to encourage participation in the capital markets, after all.
Employee Stock Options Plans
Well it's clear that the employee didn't pay for these. They borrowed them from the company until the time of exercise, in effect. Definitely, ordinary income. Come to think of it, why are we letting the company get away with promising stock that hasn't been paid for yet anyhow? That looks like a loan. This needs to be taxed. This would solve a lot of the Treasuries problems along with a lot of the problems around excessive executive compensation.
Debt Funded Purchases of Capital Assets
Why in the world, when these are resold, should we permit companies to use other people's money to get tax breaks?
I think you can see that this solves several problems.
1. It destroys the advantage of evil leverage and thereby reduces the incentive to borrow (with predictable advantages for the economy).
2. It makes everything fair. Who says life cannot be fair? Let's just move to a flat tax of 40%, in fact. That's much more fair.
3. Left as an exercise for the reader.
DealBook closes with: "You would think that all the buyout kings who wear American flags on their suit lapels would be proud to pay a big tax bill."
I think that we need to consider this too. Any true, red-blooded American firm should work hard to maximize taxes. After all, it is the Treasury that is important. Corporations that fly the American flag in over their headquarters should be proud to pay a big tax bill. We have massive unfunded liabilities in union negotiated pensions to bail out, after all.