Raising “carried interest” tax could cut PE investment by $7 billion to $27 billion, new study finds
WASHINGTON, DC – A new study tracking the correlation between tax rates and private equity investment shows that the pending proposal to more than double the tax rate on “carried interest” profits earned by investment partnerships could reduce private equity investment in the U.S. by $7 billion to $27 billion a year, with an accompanying loss of thousands of jobs.
The Private Equity Council study concludes that the rate increase could reduce the overall value of the nation’s commercial real estate assets and in turn contribute to an increase in commercial mortgage default rates.
“This data is consistent over two decades and confirms that tax increases reduce private equity investment activity and that the proposed 157 percent tax increase on investment partnerships would have a harmful effect on the economy, the recovery, and job creation,” said PEC President Douglas Lowenstein. “We have said throughout this debate that private equity will continue, but this will have an adverse economic impact.”
The PEC study analyzed reported equity invested in U.S. businesses by all types of private equity partnerships — venture capital, buyout and growth capital – between 1980 and 2009, using data provided by ThomsonReuters. During the past 30 years, annual invested equity rose from $723 million in 1980 to $49 billion in 2009. The record year for investing was 2000, when $137 billion was invested in more than 7,000 businesses.
Sizeable changes to the effective tax rate on private equity investment have been enacted on three occasions in the past thirty years: 1986, 1997, and 2003. In each of these cases, an increase in the effective tax rate reduced the growth of private equity investment and a cut in the tax rate stimulated investment, as measured in the four years before and after the rate change.
To isolate the marginal effect of tax rates on equity investment, the study excluded the effects of credit markets, the health of the overall economy and other policy changes on the investment data.
The study adopted a conservative approach to measure the investment impact of the proposed tax increase, using two separate methodologies. The first methodology measures the impact of the tax increase on total dollars invested. Using this approach, a one percentage point increase in the effective tax rate on private equity investment is associated with a $1.8 billion decline in annual private equity investment, holding all other factors constant.
Thus, the pending 14.7 percentage point increase in the tax rate – from 23.8 percent (in 2013) to 38.5 percent as proposed by the House – would result in an annual decline of $27 billion in private equity investment.
The second methodology calculates that every percentage point increase in the marginal tax rate would result in a 1.07 percent annual decline in private equity investment, holding all other factors constant. Based on 2009 investment – when investment was relatively low – that would result in an annual investment reduction of $7.7 billion.
Estimating employment effects is challenging but it is an inescapable economic fact that reduced investment depresses job creation over time. Applying the same method used by the Obama Administration to forecast the effect of the stimulus spending package on the economy, the PEC study estimates that employment could be 37,000 to 128,000 lower than it would be if the carried interest tax rates were to remain unchanged.
About the Private Equity Council
The Private Equity Council, based in Washington, DC, is an advocacy, communications and research organization and resource center established to develop, analyze and distribute information about the private equity industry and its contributions to the national and global economy. PEC members are: Apax Partners; Apollo Global Management LLC; Bain Capital Partners; the Blackstone Group; the Carlyle Group; Hellman and Friedman LLC; Kohlberg Kravis Roberts & Co.; Madison Dearborn Partners; Permira; Providence Equity Partners; Silver Lake; and TPG Capital (formerly Texas Pacific Group).
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