Money managers should pay the same tax rates as everyone else

Steven Schwarzman is the CEO of the Blackstone Group, a multi-billion dollar money management firm. He is worth billions of dollars, and isn’t afraid to spend his money lavishly:

He often spends $3,000 for a weekend of food for Mr. Schwarzman and his wife, including stone crabs that cost $400, or $40 per claw.

Mr Schwarzman pays a lower tax rate than police officers, firefighters, soldiers, doctors, and teachers. This is the due to the fact that money managers’ “carry fees” are treated as capital gains instead of ordinary income.

Last week the House passed a bill that would partly close this loophole. Sadly, with few exceptions, VC’s are lobbying against this bill, arguing it would hurt innovation, small businesses, and lots of other good stuff. As one prominent VC recently said:

[H]aving those higher taxes be levied against venture capital investments in small businesses strikes me as self-defeating when it is the single largest job growth area.

The argument seems to be that this tax will hurt small businesses. The phrase “small business” is chosen deliberately by VC lobbyists: most people, when they hear it, think of hard working immigrants pursuing the American Dream. In reality, the only thing this bill will hurt are money managers. As Fred Wilson says:

Changing the taxation of the managers will not reduce the amount of capital going to productive areas. The sources of the capital; wealthy families, endowments, pension funds, and the like, will still put the capital in the places where they will get the highest after tax return. And these sources of capital, if they are tax payers, will still get capital gains treatment on their investments in hedge funds, buyouts, and venture capital. And the fund managers will still have to compete with each other to get access to that capital and their incentives will still be to produce the highest returns they can produce, regardless of whether they are paying capital gains or ordinary income on their fees.

As Fred also argues, removing this tax break will encourage more people to go into jobs that produce tangible goods:

We have witnessed financial services (think asset management, hedge funds, buyout funds, private equity, and venture capital) grow as a percentage of GNP for the past thirty years. The best and brightest don’t go into engineering, science, manufacturing, general management, or entrepreneurship, they go to wall street where they will get paid more. And on top of that, we have been giving these jobs a tax break. That seems like bad policy. If we force hedge funds and the like to compete for talent on a more level playing field, then maybe we’ll see our best and brightest minds go to more productive activities than moving money around and taking a cut of the action.

Fred is absolutely correct. For me, though, removing this loophole just comes down to basic fairness. A fireman who runs into burning buildings shouldn’t pay a higher tax rate than a financier sunbathing on a yacht eating $400 crabs.

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http://christmasgorilla.com christmasgorilla

Chris, if they change the tax law isn't it easy to just side-step it? I mean, when the new LLC is formed for a fund, can't the various VCs just be given ownership of the fund for “material contributions” their rolodex, etc in the same way that entrepreneurs own all the equity when they start a new corporate entity?

If that's the case, does it really matter? I mean, all we're seeing in the debate is the politics of various people in PE aired out in public where the outcome of the legislation will be immaterial.

http://www.wac6.typepad.com William Carleton

Entrepreneurs own all the equity when they start a new corporate entity because they pay fair value for it. To the extent they don't pay fair value for it, or receive equity in exchange for services, they pay income tax on the value of that stock. Forgive me if I am misreading you, but there is this argument out that there that somehow founders don't have to pay income taxes when they are compensated for services and it just isn't so.

http://christmasgorilla.com christmasgorilla

William, to parse out a couple points more clearly:

1) I understand that founders pay income tax. However, when you're starting the company from scratch, the value of the options/stock/etc is so low that it's basically a non-taxable event unless you do something stupid like build significant business value without incorporating, etc. Then you pay capital gains at a later date.

2) I think some of my thinking is based on this article: http://billburnham.blogs.com/burnhamsbeat/2010/…

I'll quote the pertinent bit:

The fundamental problem for the government is that carried interest isn’t given to VCs by GPs for the hell of it, it is given to them because the VCs are investing all of their intangible assets (reputations, track records, networks, etc.) into each deal. LPs have traditionally valued these intangible assets enough to give VCs a 15–35% ownership stake in the partnership. The carried interest legal/tax structure just represented the most straight forward way, least hassle way to account for all of this. By putting this option at a significant tax disadvantage, the government is just going to force VCs and Private Equity firms to create more elaborate documentation of this, until now, implicit arrangement. My guess is that after this law goes into effect will we see VC deals restructured into something along the lines of this:

* Step 1: Create special purpose LLC
* Step 2: LP contributes $X
* Step 3: GP contributes $Y
* Step 4: GP contributes non-exclusive trademark license, promotional agreement, strategic partnership agreement, venture services agreement, and other such intangible assets as it deems appropriate in return for 15–35% of equity in SPE
* Step 5: SPE invests $X+$Y in portfolio company.

These kind of structures will cost more to set up and maintain, but they will be very hard for the IRS to attack because the VCs are getting equity for the contribution on clearly identified assets.

Now some might say, these “assets” are intangible assets and therefore the IRS will be able to claim they are bogus, but the problem for the IRS is that there are a ton of deals, outside of venture investments, that are structured exactly this way, especially in areas such as pharma and entertainment, where different parties contribute intangible assets in lieu of cash for ownership stakes. For example, there are a ton of pharma and biotech JVs and investments made by simply contributing intellectual property (patents, research, data, etc.). Thus this change is likely to set off a cat and mouse game between lawyers and tax accountants and the IRS with the only real winners being, as usual, the lawyers and the accountants (Hey start-ups, that $30K you pay to close your Series A, just went to $100K!).

http://www.wac6.typepad.com William Carleton

I'd call Burnham's argument chicanery except it's so smugly cynical and superior, it won't actually fool anybody. Anyone with a job invests “reputations, track records, networks” into what they do; you might as well add “showing up for work” and “having a pulse” to the list. What entrepreneurs exchange for their stock, however, they can't pull back out; it belongs to the entity in which they own shares, and only shares.

http://jmillerinc.com Jeff Miller

Agreed. Although the folks who pay the highest tax rates of all are the employees of money managers who actually do the work of managing the money–the PMs, traders, risk managers and so on. Their top tax rates exceed 50% in NYC.
http://avc.com fredwilson

the basic fairness argument is the best one for sure chris

but i felt like i had to debunk a lot of the other arguments too

http://www.cdixon.org chris dixon

And you did a great job of it. Thanks.
http://twitter.com/h__r__j Harshad

I completely agree with your (Fred's and Chris's) arguments. But just to satisfy my curiosity, I would like to know

* Is it possible in USA to voluntarily pay more taxes than you owe, when you feel like it?
* Are you (Fred, Chris) doing that, to set an example?
* Would you be willing to also pay back the tax breaks you have received so far (with interest and inflation accounted)?

If you do the above, it would bolster your fairness argument.

http://twitter.com/vsagarv Vijaya Sagar

Given that you agree with their arguments, your questions are of +ve interest. Not sure if expecting such Gandhian protest from Chris/Fred/Paul is right though They must already be having a tough time in the VC community for taking up this cause.

BTW, the fariness argument doesn't need any bolstering from any of these guys. As an ideal, it can stand by itself.

http://twitter.com/h__r__j Harshad

Oh noes! This is nowhere in the league of Mr Gandhi, who put his life on the line. This is just a matter of a few dollars here or there, and I don't see any need to go soft on them.

“the fariness argument doesn't need any bolstering from any of these guys. As an ideal, it can stand by itself.”

Don't you see the logical falacy here? Those who are convinced of the ideal, won't need to see the argument.

http://twitter.com/vsagarv Vijaya Sagar

Sure, don't go soft on anyone. Especially, do not spare the ones who are making an effort to be not greedy

> Don't you see the logical falacy here?

Let me juxtapose your statement and my reply. Let's see if any fallacy would emerge, logical or otherwise:

You said:
> If you do the above, it would bolster your fairness argument.
I replied:
“… the fariness argument doesn't need any bolstering from any of these guys. As an ideal, it can stand by itself.”

You were the one who saw a need for the fairness argument to be bolstered by some selfless acts from the guys your questions were directed to.

http://twitter.com/h__r__j Harshad

“You were the one who saw a need for the fairness argument to be bolstered by some selfless acts from the guys your questions were directed to.”

Yes, that's right. I still think so. And I don't believe the ideal is to pay equal taxes in the future. The very same reasons that apply to the future (and I agree with those reasons), also apply to the past and present. So, in my view, I am not expecting selfless acts much different from what they are proposing for the future.

In fact now that they are aware of what is ethically / morally right for the future, they should try to mend their past / present otherwise they are not being logically consistent. And thus, in my opinion, they lose credibility to reason or argue with others.

Here, I don't mean “should” as a moral obligation (beyond what they are already prescribing for themselves and others for the future), but as a logical obligation for consistence.

http://twitter.com/vsagarv Vijaya Sagar

Alright, now I think I understand what you are saying. I couldn't reach the same conclusions as you, following your arguments. It is good to detect a point of total divergence early enough in a debate, so as to not go around in circles trying to convince each other in vain
http://twitter.com/kishoreak Kishore

Interesting, here is a change that you believe is right. And, here are a set of people trying to steer things in that direction, while the rest either oppose it or prefer to remain silent. But you rather choose to burden this set, because you think you spotted some loophole and it makes for an interesting argument.

No wonder its so difficult to drive change in this world. Not only do you have to fight those who are against …

Chris and Fred, I dont belong to the same country where you pay taxes, but I do look up to you guys more now.

http://twitter.com/h__r__j Harshad

Can you elaborate how am I burdening them?

And no, I am not doing this for argument's sake.

And neither am I fighting them.

I am curious about their thought process for my own reasons.

http://avc.com fredwilson

i've heard that argument a bunch of times and i must say it is bullshit

you play the game by the rules that are in place

if you don't like them, you try to change them

joewallin

Fred and Chris–first, I have to say I respect both of you, for everything you do. But, of course, the easiest thing to do politically and from an argument standpoint is to stand up and say that people who make more ought to pay more. If this were a diving competition, that would be the easiest dive, so if you perfectly execute it, you still lose. But what about the more difficult arguments? I like to hear people advocate for lower taxes, in part because it is a harder argument to make than arguing for higher taxes. Here is one argument I have dreamed up in favor of lower taxes on money managers. Tell me if this is poor from your point of view. Here it is: our society as a whole is better off having professional, successful private marketplace money managers decide how to reinvest capital than government bureaucrats. Who would you rather have decide what the next great thing is–someone is some big government agency, or you and your cohorts who compete in the marketplace for the distinction as the best finder of new technologies and companies? I would favor the latter. So, in addition to just generally opposing tax hikes of any kind without concomitant spending cuts–think of it as taxgo (rather than paygo), I favor private money managers not government deciding how to invest capital.

http://www.wac6.typepad.com William Carleton

Joe, I'm not following you. How does tax fairness/end of subsidy/end of distortion in the market equate with government investing in startup companies? Are you saying that the government will raise taxes to invest in private companies? I don't think that is part of the bill at all.

joewallin

If VCs make money on carry, they usually reinvest it. Who do you want reinvesting it, smart private actors or government workers?

http://www.yourentwesplit.com Mike

With all due respect, is there any proof of this? I thought the logic was that if a fund made money on its investments over a period of time (let's say 5 years), they are rewarded with a second fund.

Does the tax treatment of carried interest affect their willingness to invest in their own funds? I honestly don't know, so any insight would be great.

joewallin

Mike, all I could reference would be anecdotes. But it strikes me as logical that capital doesn't sit still. It gets reinvested. And it is better reinvested by smart people than into government bureaucracy.

Rob K

Sorry Joe, but I don't believe that is true. Most of the VCs I know (I used to be one so I know a lot) live upscale to lavish lifestyles and invest anywhere from 1% to 10% of the capital in their own funds. If what you were suggesting were true, then they would be crowding out the pensions and endowments from their funds. But they are not.

More importantly, what you're arguing is for lower taxes. I get that. What Chris and Fred (and I agree with) are arguing is for tax fairness, that carried interest isn't really a capital gain because it's other people's money.
Michael

Joe,

Your 'smart people' argument asks government to treat money managers differently because they are 'smarter'.

I am not a money manager. I worked in a hedge fund for some time and quit to pursue my passion, scientific research. I feel like I am as smart as the next guy. Your arguments apply, without modification, to me. It follows that they are therefore bad arguments for why money managers should be treated preferentially by the tax system.

joewallin

Michael, my first reply to Chris on his post was–yeah, we should cut the top income tax rate to 15% immediately for everyone. So, I agree with you that your rate should be lower as well. Basically, the problem with progressive rates is that the government is then in the business allocating capital. Our economy works better with private actors rather than the government allocating capital (at least, that's my opinion).

http://avc.com fredwilson

i don't see how you get from “carry is a fee and should be taxed as such” to
the government deciding what new technologies should be invested in

your logic escapes me

joewallin

Fred, if the government takes the money in taxes it hires census workers. If it leave it with you, you fund the future. I prefer the latter.

http://avc.com fredwilson

i'm still funding the future

and the point is that i do it with other people's money

so if they take a little bit more from me, that's ok

joewallin

Fair enough Fred, but my point–and I am trying to make the harder argument that people who make more should pay a lower tax rate, is that if the government taxes the money away from super smart people, our society will be less well off–because the super smart people would have more efficiently deployed the capital than the government (my example, you fund tomorrow's companies with the extra money–and you have more “skin” to put in the game!–while the government spends the money in inefficient bureaucracy).

A corollary of my argument is this–the higher the tax rates, the less capital there is for startups, and that is a Societal Bad which you need to weigh against your perceived Societal Good of the fairness of higher tax rates on money managers.

http://avc.com fredwilson

i still have plenty of money to invest wisely

joewallin

ok, and that's great, but from a societal point of view–who do you want reinvesting capital to grow the economy–smart money managers or govt employees?
http://www.bp-3.com/blogs sfrancis

I don't think you get extra points for making the “harder argument” if it is wrong I mean, you're not arguing for a flat percentage tax, you're arguing for regressive taxes. wow.
joewallin

sfrancis–yeah, I think the flat tax is the answer.
ryandavies

again, very few smart MM managers out there. how many predicted the downturn and made money for their clients by shorting the markets?

ryandavies

how do you define these so called “super smart” people? There are actually very few. All the rest just ride the waves of markets, taking fees and promotes where they can , and disappearing (or making excuses) when things go the other way. I would agree that super smart people should have better access to capital, however, our current system doesn't separate the wheat from the chaff, and even incentivizes people to be “super sleezy”.

http://www.linkedin.com/in/rajatsuri rajatsuri

Why is it bullshit again? Don't you think leading by example is effective? It'd make quite a statement (or as investors call it, a 'market signal') if you announced on your blog that you'll be voluntarily paying higher taxes because you strongly believe that you shouldn't be paying lower taxes than firemen.

Of course, you may believe you shouldn't be paying lower taxes, but not strongly enough to do that. Which is a fine admission to make, but the argument is not bullshit.

http://avc.com fredwilson

it is bullshit to argue that i should voluntarily pay more taxes if i think
tax policy is unfair

i feel that it is better to give the money away to charity, which i do

http://www.linkedin.com/in/rajatsuri rajatsuri

I applaud you for donating the money to charity – I also believe that money
creates more benefit than most taxes end up doing.

But here's my question – if you do believe that you can spend your money
better than govt, then shouldn't you still want your taxes to be lower?

I know it's unfair relative to firemen/teachers – I don't argue with that
point. I also don't argue with the point that the federal budget needs
balancing. But is it ever a good thing to increase taxes? Why not just cut
spending, especially on the expensive military actions that have led to the
massive deficit.

Personally I rather see ordinary income taxed for less – I can't see higher
taxes benefiting too many people. Increasing your taxes might sooth some
hurt feelings amongst firemen, but in the end, the charities and causes
you're donating to could be the ones to lose out, no?

http://blog.jeffreymcmanus.com/ Jeffrey

> if you do believe that you can spend your money
better than govt, then shouldn't you still want your taxes to be lower?

This is another bullshit argument; it's a function of Reagan's Big Lie which is that government's intake of funds should ultimately be $0. The fact is that business spends money sometimes efficiently, and sometimes not so efficiently, and that government spends money on things that business won't spend money on.

I don't understand why, in 2010, this should come as news to anyone.

http://www.linkedin.com/in/rajatsuri rajatsuri

You misunderstand my argument completely. I'm not arguing for $0 taxes. I'm
not Reagan – I believe govt is essential for public services like roads,
environmental protection, security etc. I just believe that there should be
a force pushing govt to spend more efficiently, and that force is generally
voters' wish to be taxed less.

Fred clearly states that he believes he can distribute funds better than
govt to charitable causes. If he had to pay higher taxes, it is logical that
some of the charities he funds would suffer. Why is that a good thing? Is
the 'fairness argument' strong enough to balance the lost benefit of the
charities?

http://avc.com fredwilson

who is going to pay for medicare, medicaid, social security, our schools,
our military?

of course i want my taxes to be lower

but more than that, i want to see this country operate a balanced budget

we can't simply keep borrowing money

we have to generate revenues in excess of our costs

http://twitter.com/h__r__j Harshad

Ah thanks for your time. My curiosity was satisfied although in an unexpected way!

Ryan

Damn right!
jd

The biggest myth ever is that VC-backed tech startups create jobs. The real job growth engine is in normal small businesses (ie, dry cleaners, indie sales, retail boutiques, professional services, etc). If anything, tech startups kill jobs due to their primary focus on productivity gains.
http://keithbnowak.com/ Keith B. Nowak

Couldn't agree more.
AM

Who cares about your arbitrary definition of “fairness?” If passed, this bill will offshore the private equity industry. I sure as hell wouldn't be a VC in this country if I could do nominally operate in another country and pay half the tax rate….

http://www.cdixon.org chris dixon

It's called ethics. If you really believe it use your real name-
coward.

http://MeetInnovators.com Adrian Bye

do you think if you were running a late stage big fund you'd have the same position as you do now, running an angel fund?

http://www.cdixon.org chris dixon

In big funds you get rich off mgmt fees alone. In little funds you
can barely pay expenses with mgmt fees, hence ALL your profits come
from carry.

http://twitter.com/vsagarv Vijaya Sagar

Some brave anonymous VC you are. Give us your name and we entrepreneurs will avoid you.

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Brian Hirsch

Chris,

What's missing in this argument is that many VC funds are also entrepreneurial ventures. I left a secure position to move back home to NY in 2004 to start a VC fund from scratch at the ripe age of 30 years old. I self-funded all the way despite the tremendous odds against me at the time. I took this risk at the time knowing that if I was successful raising the fund AND made great investments while working my ass off to help the entrepreneurs I back that I would reap the economic rewards from my great risk. Now having to face the those rewards cut in half after the fact is demoralizing and as you stated earlier “unfair.” I'm not alone in this situation. It actually represents almost all of the emerging VC fund managers that are the future of our industry. Very few VCs are Fred Wilson and raise capital quickly with little risk. Even Alan Patricof needed 18 month to raise his fund recently.

Brian

http://avc.com fredwilson

brian – my partner Brad and I spent 18 months in 2003 and 2004 working without any income and came out of pocket about 250k each to get USV started. I know what you are talking about.

if we sell our firm, we should get cap gains treatment

but we should not get cap gains treatment on our revenues

brianhirsch

Fred,

I think we both know the sale of a venture capital firm is a rare occurrence and not a realistic exit for 99% plus of the funds in our industry. For our industry the carried interest gains represent the exit.

Let me explain another way. Using our $100M fund as an example, assume we originally structured our fund as a C corp where our investors received a participating preferred with a 1x liquidation preference and “management” received 20% of the overall equity in common stock. How is what we do that different from the entrepreneurs except for our legal structure. I couldn't disagree more with Chris Dixon's assertion that VCs move money around. Many of us work hard to create real value in our portfolio companies. I believe the entrepreneurs I work with would say that in many ways I'm an extension of their management team (in a good way). Good VCs think of themselves as company builders, not money managers.

Ironically, if our industry was legally structured just like the companies we back and there would be no issue right now. Every investment would be similar to a sub in an operating company and we'd sell them one by one. If the tax laws do in fact change then we may be headed down this path anyway. The only people to gain will be lawyers and accountants.

Finally, the #1 issue I have with the potential tax change as drafted today is there's no clause to grandfather in existing funds. Every VC raised their current 10 year fund under a certain set of tax rules and the rules shouldn't be changed under their feet mid-stream. At the very least, have the tax increase only apply to funds raised starting in 2011, or better yet 2012 since many VCs started their fundraising process a while ago and may not close until sometime next year.

http://avc.com fredwilson

maybe you should set up your firm as a C Corp and build equity value that
way. i would have no issue with you getting cap gains if you did that. but
getting liquid on that equity value is hard as you point out.

the structure our industry uses as well as the structure the hedge fund and
buyout fund industries use is taking fee income from our investors for the
performance we generate. that's a fee and should be taxed as such.

the C corp approach is a much riskier and more illiquid approach and but
certainly should qualify for cap gains treatment

brianhirsch

I just don't view carried interest in a venture fund as fee income. The carried interest is generated by gains in the value of the equity in a fund's underlying companies. Just like the restricted stock used in private companies, a basis is set for each company a venture fund invests in at the time of investment. I don't feel the equity gains that are generated by the fund should be taxed as income vs capital gains. Any carried interest payable to GPs is created by a capital gain from an equity investment, not fees. If the carried interest was created by dividends provided by portfolio companies then I can understand a higher level of taxes.

Additionally, a change in the tax law now puts the entrepreneurs we back one step closer to the same higher tax structure. How long will it be until Congress is seeking even higher tax receipts by using the same logic so they can tax founder's stock at ordinary income tax rates? I can see a scenario where a VC fund invests $5M into a private company enabling the company to build $100M in value for founders instead of $20M. The entrepreneur in this scenario is leveraging other people's money to create a larger equity gain for themselves. This doesn't seem to different than VC funds leveraging other people's money to create a larger equity gain for themselves.

http://bsiscovick.tumblr.com/ bsiscovick

Brian, ignoring your second hypothetical for now – you say 'any carried interest payable to a GP is generated by a capital gain from an equity investment.'

While this is true, the issue is *whose* equity is it. If the GP contributes capital to the fund, the gains on that equity is taxable at the capital gains rate. But capital gains on equity contributions of others is not the same. Sure the gain is on an equity investment, but it's on someone elses money and not the GPs own risk capital. That in mind, CI feels more like fee income to me.

http://www.rre.com jdrive

“…the gain is on an equity investment, but it's on someone else's money and not the GPs own risk capital.”

But by that logic, as most startup companies are built with OPM as well, and asset appreciation is highly-correlated with this money with a few notable exceptions, then, what? Entrepreneurs at these companies should also be taxed at a full amount? Is 'sweat-equity' in just one business truly different than sweat-equity in multiple businesses?

This is the problem with using personal 'risk capital' as the standard; fact is, entrepreneurs are — and should be — paid off the value creation of their stock, though in most cases (at least for the younger ones) they have little in the way of actual 'risk capital' invested. What they do have is a bucket-full of dedication, sweat, hard-work, tears, etc., in the game. As do I. Certainly not anything close to the same amount in any given company, but overall? Absolutely.

Rob K

It's not the same at all. The entrepreneur doesn't get to live off the fees from his VCs, pocketing the gains. His payday comes at the end, not all the way along, and he's often compensating for hugely under-market wages during the start-up phase.

http://www.rre.com jdrive

Few small & even mid-sized vc's 'live off fees' in a meaningful way. My base (I have no actual bonus component other than carry) is not that dissimilar to the base/bonus current comps of many of my ceo's, particularly the more experienced ones. Some earn more.

Sure, for large funds, and virtually all PE, LBO & hedge funds, that is absolutely true.

As a friend and large hedge fund manager once said to me… “Robinson, when are you going to wise up and raise a much larger fund. You'll make tons more money on the front end, and if the deals work, so much the better”.

Maybe he was right. But I would have had to move too far up the food chain where I have much less passion.

Sounds like you have VC experience, so you can do the math. We currently have a $300 mil fund, several years in, tail kicking in (meaning reduced fees). 17 People. Until a few months ago two offices (NY & Silicon Valley). 6 GP's. Global travel bills. Get the picture? Listen, we earn a good living, sure. but 'pocketing gains'? Um, no. Any real money made is on realizations from carried interest. Not like we're going public anytime soon.

Incidentally, it is only for this specific type of venture firm that I am arguing another side to the carry debate. Certainly not for larger firms where what you say is absolutely the case.

Rob K

The fact that I may be wrong about your fund has not convinced me about the VC or PE industries. Funds that are on fund 3, 5, or 10 generate tens of millions of fees annually and the GPs make no less than $500K in salary/bonus BEFORE carry. That is true about every [fill-in-the-blank] brand name fund. and yes I can do the math- 17 people and 2 offices is a lot for a single $300MM fund.

brianhirsch

Ben,

I think Jim stated my thoughts on other people's money very well. Entrepreneurs are also utilizing OPM to create more equity value for themselves, just as VCs do by taking money from LPs. Entrepreneurs use our capital to create products, hire talent, fund sales and marketing, etc.

http://avc.com fredwilson

that would be true if the LPs gave you the money and you invested it in your
own name

but they don't

they give you 20% of the gains you generate

and that is a fee
http://avc.com fredwilson

i would fight the government's efforts to tax entrepreneurs cap gains as
ordinary income tooth and nail

i don't see that the same way at all

they are not investing capital

they are building it

brianhirsch

I would be standing next to you on Capitol Hill fighting tooth and nail as well. The problem is neither of us control Congress. Just because you don't see it the same way as I stated it doesn't prevent Congress from combining the concepts.

It seems the best way to protect the innovation economy that's so unique in our country is to build a moat around all of the constituents that drive it and protect it as much as possible. One thing I know is innovation works here better than anywhere. We have the best risk capital system on the planet. Why mess with success?

Also, I may just be looking at this through a different lens. From my viewpoint, I'm a partner with my investors and a partner with my entrepreneurs. All of us bring different things to the table to create what is currently the most powerful innovation machine in the world. You can't bake a good cake without all of the ingredients and trying to say one ingredient is more important or should be given a different status seems wrong.

I think that's why a lot of entrepreneurs have been very supportive of fighting the tax changes to carried interest. They may not be vocal on this blog or on twitter but there are many out there that signed the NVCA petition and have reached out to me over the last few months. I even had 2 of the entrepreneurs we backed send me the petition before I was even aware of it.

I like to think the reason they are supporting no changes to carried interest taxation is because they think of me as a partner, not just a guy that moves money around. I've never eaten a $400 crab and don't even like crabs – much happier with a $2 piece of pizza

All the entrepreneurs I work with know I will take a call at 1am to deal with an issue, will fly across the country in a moment's notice to help them close a sale or biz dev partnership, will spend hours both identifying and selling potential recruits to join the company, etc. Many of the VCs I know work just as hard to provide the same type of value. We haven't partnered on an investment but I'm sure you do the same. All of these things build real equity value for entrepreneurs. Why should our contributions not be recognized the same way in the tax system? To me, that seems unfair.

http://avc.com fredwilson

i don't think congress will go after entrepreneurs

this is about going after money managers who make millions and pay a lower
effective tax rate than many ordinary workers

the truth is most VCs are making management fees in the millions per year

the carry is on top of that

the financial risks we take and sacrifices we make are not close to what
entrepreneurs take

the best VCs, like you, do work hard and add a lot of value

but many, maybe most, add no value and often subtract it by giving companies
bad advice and firing founders and doing all sort of bad things

the hedge fund, buyout, private equity, and venture industries deserve what
is happening to them. the level of arrogance and hubris has been over the
top. and the compensation has been too.

maybe it is because i live and work in NYC that i am so sensitive to these
issues. the vast amounts of wealth accumulated by money managers in the past
two decades is obscene.

brianhirsch

I agree fully with your comment as it relates to PE funds, hedge funds and even large VC funds. Being born and raised in NY and now running a fund here I'm all too familiar with the arrogance and hubris around us.

I would like to see Congress make a distinction between smaller funds, particularly those focused on seed and early stage, where the managers aren't getting rich from management fees. In fact, there are quite a few $25-$150 million venture funds where the partners earn the same or less in annual comp than VC-backed CEOs. Higher taxes on risk capital for a group of seed/early stage investors that act as a linchpin for the innovation economy feels like the wrong move at the wrong time. Parsing out the smaller funds would have little to no impact on the govt's tax receipts but would preserve a system that's working just fine.

Overall, I don't think there's a right or wrong on this issue but a more nuanced thought process should be considered to avoid damaging a healthy part of the economy.

Unfortunately too much of the rhetoric on this issue has been portrayed as good vs. evil, us vs. them, entrpereneur vs. VC – and it's a shame.

http://avc.com fredwilson

maybe early stage VCs should be putting their 1%, 2%, or 5% GP commits
directly into the company as direct investments in the first round

that would be good for a bunch of reasons, including allowing us to get cap
gains treatment on the most highly leveraged of the rounds we do

we do it that way at USV, but we do it pro-rata across all of the rounds not
just in the first round
brianhirsch

We do the same GP commit pro-rata across all of rounds. My GP commit represents about 125% of my annual cash comp so I'm fully aligned with my LPs and entrepreneurs (but not always my wife).

I like the idea of putting the full GP commit into the first round as an offset to higher carried interest taxes. It's a creative approach. I just wonder if LPs will be put off by it since interests will not be aligned as closely. LPs may be concerned that some funds will follow-on in weaker companies just to protect their GP position. I don't think most funds would act this way because they would be putting their long-term viability at risk, however, LPs are sure to raise it as a potential issue.

joewallin

Fred, you don't think the new S corporation tax provisions are essentially Congress going after entrepreneurs? See my blog on this, http://bit.ly/d5mZUM. See also The Hill, at http://bit.ly/bN19fG

Rob K

Brian, seems to me that the “gains in value” that you are arguing are gains on OPM and therefore are ordinary income. But I see your point about the sweat equity in starting a new fund. Managers should build that in in the negotiations with LPs.

http://ffassetmanagement.com/ John Frankel

Fred, given that selling your firm would be selling the NPV of future profits then this government will want to tax that also as income – just to be consistent.

http://pegobry.tumblr.com/ Pascal-Emmanuel Gobry

Uh, no. That would just lower the valuation.

http://ffassetmanagement.com/ John Frankel

Probably not lower the valuation, but lower the proceeds to the sellers as Uncle Sam takes his stake

joewallin

agree we should cut tax rates across the board to match the 15% capital gains tax rate

brianhirsch

agree completely. Reduce gov't spending and taxes across the board.

http://bsiscovick.tumblr.com/ bsiscovick

I'd really like to agree with this, but the unfortunate reality is that we need to *cut* spending and *raise* taxes.

Maybe down the road we can rationalize lower taxes with reduced spending but I think we need to go through much more painful systemic deleveraging first.

observer

fine then propose spending cuts to pay for it or you're just being unserious.

Barry Anderson

See Shockwave Rider (Brunner?) for an interesting proposal for taxation basically there's three axes: training, need can't remember the third but I think it's something to do with undesirability of the role…

Cheers.
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observer

this attitude is pretty typical of most elites in our society – they are basically greedheads who don't care about anything but themselves. guys like Fred are the exception not the rule unfortunately – Blankfein types are the ones calling the shots these days.

there is no good reason for capital income to be taxed at half of what labor income, it is just flat out class warfare.
http://www.seeingbothsides.com bussgang

Hey Chris – since I'm the “prominent VC” (thanks for that, BTW, my mother would be proud) you reference and since you link to the NY Times article which has an inaccurate reference to me, I wanted to make sure I set the record straight. First, on the NY Times article, as mentioned, I never led a lobbying effort on carried interest and the NY Times never spoke to me about the story they wrote http://bit.ly/blmOkA. Putting my annoyance at being misrepresented aside, I have very mixed feelings abou the whole carried interest debate, as I blogged back in 2007 (http://bit.ly/a9oxQr). On the one hand, it's not fair for wealthy asset managers to pay lower taxes – I agree with you 100% on that. Rich people need to shoulder the burden for the masive deficit and a combination of higher taxes and spending cuts is the only way to make the math work. On the other hand, I question whether raising the carried interest tax on VCs (not hedge funds, but VCs only) is the most productive place to raise taxes as compared to others. It probably won't have a big impact on the VC industry (hard to imagine fewer VCs or VC funds as a result of higher taxes given how great this job is), but anything that on the margin creates a disincentive for capital to flow into small businesses is bad policy, in my view. In any event, I'm no macroeconomist or politician, so I'll leave to them to figure it out. I just wanted to set the record straight on my position and correct the misrepresentation. Thanks for pushing the dialog forward.

http://www.cdixon.org chris dixon

Sure we all have our ideal tax systems but the reality is this is the bill that has a decent chance of actually passing. It feels diversionary to talk about how there are better alternatives. This is a moment of truth for money managers and which side you line up on says a lot about your character.

I can't believe someone from the top of his class at Harvard is seriously arguing this will hurt investments in small businesses. Can you please try to answer Fred's argument and explain how this will cause 1 fewer dollar to be invested in startups?

http://harryh.org harryh

> Can you please try to answer Fred's argument and explain
> how this will cause 1 fewer dollar to be invested in startups?

I basically agree with your overall point, but I can make this argument:

1) raise taxes on VC income
2) fewer people will want to be VCs
3) the overall quality of VCs will go down
4) the overall quality of VC decision making will go down
5) the overall rate of return on VC investing (what the LPs care about) will go down
6) less $ will be given to VCs to invest

I'm not saying the affect will be large, but I think it'll be there.

http://twitter.com/davekinkead Dave Kinkead

@harryh

Your premises 3)-5) and conclusion rest on the false assumption of 2).

Fewer people will want to become VCs, only if the increase in tax rate makes other work options more attractive in absolute terms.

If working as a VC is taxed at the same rate as working as a fireman, then the effect of taxing CI as income will be incentivise people to work at what they do best, thereby improving overall returns to the economy.

More to the point, taxing CI as capital gains creates an artificial distortion that actually lowers the overall quality of VCs. This is because lower quality players will enter the market due to the easier, artificial returns thereby…

4) the overall quality of VC decision making will go down
5) the overall rate of return on VC investing (what the LPs care about) will go down
6) less $ will be given to VCs to invest

Taxing income as income only makes the economy more efficient.
http://twitter.com/h__r__j Harshad

Hmm.. by that argument…

1. Firemen pay large taxes
2. Fewer people will want to be firemen
3. The overall quality of firemen will go down
4. The overall quality of fire fighting effectiveness will go down.
5. The survival rate of people will go down
6. There will be fewer people, and hence fewer VCs.
ryandavies

you assume (good) VCs are only motivated by money. bad assumption.

http://www.seeingbothsides.com bussgang

Chris – I have mixed feelings here and don't see things as black and white as you describe. The fairness argument is compelling and politics is an imperfect sport, so perhaps we should seize the rare opportunity to take a positive step towards deficit reduction with modest negative impact. That said, capital and talent flows are hard to predict, and it's hard for me to believe that doubling the tax rate on anything will have zero impact. I'm no economist or policy wonk, but the tax system is an incentive system. If you make it less economically attractive to be a VC investor, then top talent may choose to pursue other professions on the margin. The increase in taxes may put more pressure on LP terms, which may reduce capital flow on the margin. The good news is that the VC business is a super-attractive and rewarding one for numerous non-financial reasons, so you may be right that the impact will be zero. And to be clear, I hope you're right – I hope the higher taxes ends up being an easy deficit-reduction tool that won't impact small businesses or the start-up ecosystem. It looks like some form of the higher taxes will pass, so we'll all get to see how it plays out over the coming years.

http://twitter.com/cdixon chris dixon

It genuinely saddens me that (to my knowledge) only me, Fred Wilson and Paul Kedrosky support this tax bill. VC industry really missed a chance to take the high road.

http://twitter.com/skaye Sean Kaye

I find it amazing that this argument has shifted to, “Well talented people may not become VCs because they have to pay their fair share of tax”. Come on @bussbang not one VC will give up this gig because of this tax change. If these rats are sniffing around for their next unfair tax break, then let them go and people will sniff that out and get rid of it too.
http://avc.com fredwilson

chris, there are plenty of others. but they work in partnerships where they have reasons to stay quiet.

http://MeetInnovators.com Adrian Bye

i wonder if there is some relationship between vc's considered entrepreneur friendly and supporting this bill.

http://twitter.com/jckhewitt JC Hewitt

I don't get how VCs giving more money to the government (that they might otherwise invest into companies) is exactly “entrepreneur-friendly.”

I'll be blunt and state that private equity itself is a legal construct designed to minimize taxation. It has no other purpose, stripped of the jargon.

So yes, in that way, it's unfair, anti-competitive, and allows private equity firms to run roughshod over small businesses that can't afford lawyers. That's an effect of the legal system, the tax code, the currency system, the financial system, and our culture.

So by raising the taxes… you're destroying the only advantage that these kinds of firms really have.

http://twitter.com/sachinag Sachin Agarwal

Let's be clear: the VCs who publicly support the change in tax rate to make it fair so that their income/salary is taxed at the same rate as entrepreneur income/salary will have an advantage in deal flow. Do you think we're not paying very close attention to those VCs who are truly aligned with us as opposed to those who merely claim it?

http://markloranger.com Mark Loranger

Sachin, I think your comment could be confused as saying the VCs who support the bill are actually acting in self-interest. Like: “Hey, I'll be the outlier, make the entrepreneurs happy, and all the best deals will therefore come to me”. Did you mean it that way? I'd like to believe that the “3″ vocal guys who support this aren't acting in self interest. But if they ARE – they're very clever indeed…

From my perspective, if they were lower tier VCs, this tack would make a little more sense to raise their profile and give them some cachet among entrepreneurs. I don't think Fred or Chris really need that.

http://twitter.com/sachinag Sachin Agarwal

As an entrepreneur, I couldn't give a damn what their motivations are. If they're on my side, then that's a good thing.

However, since you asked, in the case of Fred, Chris, and Paul, I'm convinced they're genuinely on the side of the angels.

http://bsiscovick.tumblr.com/ bsiscovick

I generally don't disagree with you, but this comment is highly unfair. It's one thing to proactively lobby against it, it's quite another to passively support it. I don't actively blog every time I support an initiative because a) I don't have time and b) smarter people do a great job sharing more insightful thoughts than I ever could.

Also, I love what I do and would do it irrespective of the tax policy around it. And while I'd love to fight for every just cause, I simply don't have the bandwidth to do so. Point being, silence and lack of support are far from one and the same.

I like to give people the benefit of the doubt and believe many others in our industry share my sentiments.
http://www.linkedin.com/in/rajatsuri rajatsuri

It genuinely saddens you that people want lower taxes for themselves? I don't think you have much of career in politics, or you'll be in tears most of the time.

http://avc.com fredwilson

that is the one argument that holds some water in my book Jeff. but the best VCs don't do their jobs for the money. they do it because they love what they do. i suspect if we lose people in this business because of higher taxes, we'll lose people we are happy to lose

http://www.elieseidman.com Elie Seidman

So true. Having met many VCs over the years, it's easy to spot the ones who are passionate about product vs those who are passionate about money. Being passionate about the former tends to lead to the latter anyway.

The argument that there are not enough talented people looking to become VCs defies everything I have observed; There are far too many top people who want to become money managers, not too few.

http://alephblog.com David Merkel

I agree, but this is too small. We need to redefine income, and eliminate the ability of anyone to defer taxation.

http://alephblog.com/2008/04/12/problems-with-tax-reform/

Tax everyone like a trader. Warren Buffett must finally pay his fair share. No more deferral.
http://marklogic.blogspot.com dave kellogg

Couldn't agree more. Basic fairness is what this is about. And it's a little scary how the financial folks got carried interest treated as anything but ordinary income in the first place.
http://blogs.forbes.com/digitalrules/2010/06/the-millionaire-cop-next-door/ jp

http://blogs.forbes.com/digitalrules/2010/06/th…
http://alephblog.com David_Merkel

I agree, but this is too small. We need to redefine income, and eliminate the ability of anyone to defer taxation.

http://alephblog.com/2008/04/12/problems-with-t…

Tax everyone like a trader. Warren Buffett must finally pay his fair share. No more deferral.
http://www.Fishcoin.com B Maddigan

Greetings Honorable Brother Chris,

Please see: http://twitter.com/Amenamen

& http://www.Amenamen.com

Help Us spread His Living Word…

And Thanks SO Much… <'(((><

ryandavies

this doesn't belong here. we really need a dislike option on Disqus

http://twitter.com/servicetattler Service Tattler

Is basic fairness really coming back in vogue? I certainly hope so. Love what yer doing Mr. Dixon.

http://twitter.com/cdixon chris dixon

apparently basic fairness is radical and has been proven destructive by economists at U of Chicago.

http://twitter.com/vsagarv Vijaya Sagar

Chris, your subtle humour might miss those who do not know of your high regard for 'economists at U of Chicago' ;^)
http://twitter.com/jckhewitt JC Hewitt

Chris, this administration runs on the Chicago school. Ever hear of a guy named Larry Summers?

No tax increase will make the Federal government even vaguely solvent. This bill is just playing for political points. Punishments for WS poll very high. That's about it. Glance over at the UK and the massive cuts that they're making. That's the fate of the US, except much worse and more severe.

I have no idea why you're arguing against your own long-term interests and those of your employees. That's not noble. It's suicidal – unless you're lobbying for a government job.

This government is more screwed from a fiscal perspective than Hungary or Greece. As I mentioned earlier, even Buffet is saying that the Fed will bail out municipalities. If that happens, the US will lose all legitimacy as a functioning government.

http://twitter.com/jckhewitt JC Hewitt

Warren Buffet cheered the government his whole life. He was recently subpoenaed and is now being raked about Moody's. He's now supporting bailouts for municipalities.

(http://www.businessweek.com/news/2010-06-02/buf…)

Goldman Sachs served the government without question for decades. Now they're under investigation, with criminal charges rumored.

If you're really looking to stoke populist approval, perhaps it's wise to point out just how regressive our tax system is. If you want to get really sensible, maybe you'll bring up how the Fed's inflationary policies hammer the working and middle class much harder than any tax.

The fact that venture capitalists even have a lobby at this point is an indictment of their judgment. Better to let Washington hang itself than try to rescue it from its own malfeasance. Let 'em pass the tax increase. It'll be darkly amusing to witness the unintended consequences.

I guess it makes sense as to why established VCs would cheer higher taxes. It means less competition from upstarts. It'll be tougher for others to accumulate as much capital as quickly.

The costs will just be passed down to shareholders and entrepreneurs, who can scarce afford it any longer. With equity markets getting hammered (and I doubt there will be much of a recovery), I doubt that VC in general is going to perform well, in any case.

You made plenty of money with some great calls, taking advantage of a temporary state of affairs and a favorable tax environment. So now, in time-honored fashion, you support a measure that would hamper smaller competitors.

How tough is it to offshore capital, anyway? Call some lawyers. Figure out the issues. Transfer the money elsewhere. The end! Web businesses don't need US real estate. Congress doesn't understand and it doesn't care.

Maybe we should all go work for Raytheon. It'd be thrilling to work on the next-generation missile that can kill Afghan teenagers with 32% more efficiency.

That's something that you can brag about to your grandkids, some day. Just think about how many assassinations this tax increase could pay for! Hot damn! How many man-pyramids! The social benefits will be incalculable.

If Steve Schwartzman wants to eat crab on his yacht because he's making a lot of money for his shareholders, let him savor it.

You also forget to mention that the tax advantages are one of the only reasons why certain firms – that don't do nebulous web-based things – can stay in the US. Look at Duane Reade for an NYC example. They would be dead without the tax protections. All those people that work there would be back on the dole without the favorable tax treatment.

I find it telling that you consider someone that makes money a greater sinner than the government that – hello – tortures people for kicks, murders people by the hundreds of thousands, keeps more people in prison for non-violent offenses than were ever kept enslaved in the Antebellum South… and on, and on, and on…

Yet you like it! You love it! Baby, you want more of it!

And the boot-licking position is supposedly the ethical one, now? How precious. And it's supposedly “cowardly” to oppose a tax increase? Your side has nukes! Guns! Soldiers! How noble of you! What a fierce little warrior you are!

“Capitalist” is in your job description. Doesn't seem accurate to me.

http://twitter.com/vsagarv Vijaya Sagar

JC, your 'failoften' blog seems to be a far better reflection of your reasonable writing and creativity, than this rant here. Unless of course, you have definite proof of Chris, Fred and Paul being this age tech VC mafia who want high taxes to pre-empt competition from new VCs. You should know that the rest of the VC community would love to get taxed too, if that is all it takes to keep new entrants from entering the VC business.

I wonder if some people jump into a debate just for the heck of it and take up an untenable position with arbitrary & irrelevant arguments.

http://twitter.com/jckhewitt JC Hewitt

How is this untenable?

I'm not against just one tax, but the entire governing philosophy behind these kinds of arguments. At least in that respect, I'm consistent.

I try to avoid getting into politics for this reason. It appears that you have to join a political club in business to hang out with the cool kids. It was that way under Bush, and now apparently it's that way under Obama. In the US, you always have to pay lip service to the ruling party.

I resented being told by Fred that the Democrats are the “party of the future” in his comment thread some months ago. Politicking has no proper place in business. I resent all these lunatic lobbying efforts, even if they're a “necessary” cost of doing business.

I never claimed that they were part of a “mafia.” That's a strawman argument. But when you're arguing for higher taxes – and claiming that it's *moral* and *fair* for those tax increases – then that's bizarre.

I'm not upset with Paul, because as far as I can tell, he hasn't started lecturing about why we should pay higher taxes as a moral obligation. If he says “ok, whatever” just as part of business, then I could care less about that.

It's the lecturing about “fairness,” the Democratic party, and “financial regulation” that nauseates and infuriates me.

Especially when a certain favored class of business can borrow from the freakin' discount window.

Normally, I'd keep my mouth shut, but with many European governments in a state of fiscal collapse with NY and the rest of the country not far behind, it's important to start speaking out seriously about these issues.

Shutting out competition is the practical effect of tax increases, as it always has. It also pushes more companies to seek out tax credits more aggressively.

But those are just the effects. I'm more concerned about the moral rot and the anti-capitalist tendencies shown among many in the business community. Not to mention the brazen lack of concern for shareholders. The government kills and jails people every day… so to claim that we should pay higher taxes out of some kind of bleeding-heart moral obligation is insulting.

Thanks for the compliment. I aim to please. Except when I'm angry.

http://twitter.com/vsagarv Vijaya Sagar

Chris, it is quite surprising that just 3 VCs are for basic fairness. Well, that does clear up some misconceptions about some highly respected VCs. Though, I still want to believe good guys like Khosla & Conway share your views but are just not as publicly vocal as you. I also hope that they are probably working behind the scenes to fight NVCA-lobby and help fairness prevail in the Senate vote.

VC business is not for those who are in the “game” for money and money alone. They must have the love for helping create and sustain successful startups.

If easy money is all they need and they have it in boatloads, they can sure go to some tax haven and run a casino where the house always wins and it is such a paradise.

And instead of trying to save tax pennies, VCs can make lots of money by taking the more honourable and exciting route of consistently attracting high quality entrepreneurs.

http://avc.com fredwilson

there are plenty of others. they just don't work in partnerships where it is ok to say what you really feel. in our partnership, all three of us feel the same way so its easier.

http://twitter.com/vsagarv Vijaya Sagar

Fred, I understand. You obviously know more than I do and are probably hearing them support you discretely. Yet, such people can blog in individual capacities with a disclaimer that their personal opinion is neither representative of their partnership firm's nor is it binding on their firm to endorse their views.

To give an example: There was this VC guy 'AM' who posted an anonymous comment here (who was duly called a 'coward' by Chris). My reply to him was to the effect that if he shows his face I would ensure he doesn't get a chance to invest in my startup. That's my personal opinion and am sure my co-founders / my company would tread more carefully in ticking of a VC

In summary, people must speak out their convictions or risk their silence being misunderstood.

http://avc.com fredwilson

it is not so easy

let's say you are a junior partner in a firm run by a couple of guys who
have been in the business for years

and they are ripshit pissed off about their taxes going up

are you going to blog on your own blog that you think their taxes should go
up?

i don't think so

http://twitter.com/vsagarv Vijaya Sagar

Fred, I do not want to pontificate. Definitely not to you.

To answer your hypothetical case, I will blog my stance. I'd expect those guys who run the firm to call me up, have a chat with me and decide whether they respect my personal stance. If they don't, I get up and walk. <irresistible-pontification> Because, there is no point in having half-hearted convictions. </irresistible-pontification>

I do not think those who already support your argument should be drawing your energy away from the main debate. So, let me not take your time. Keep going and good luck.

http://bsiscovick.tumblr.com/ bsiscovick

This is an unfair extrapolation. I'm supportive of the increased tax rate but a) am way too busy doing my job and b) have nothing super insightful to add beyond what other smart people have already contributed to spin cycles blogging abt it.

I am sure there are plenty other of VCs who feel similarly.

I appreciate your passion for this issue, but its not fair to infer too much from a non-comment.

http://twitter.com/vsagarv Vijaya Sagar

I understand what you say and appreciate the reply. I must've come out as unfair, but am probably not alone in thinking so.

It is quite possible that many VCs are on this side of the debate and do not have the time to blog/tweet. They can just 'Like' one of these blog posts (not anonymously). That'd be a good enough show of hands.

http://blog.redfin.com GlennKelman

Of note, the VCs are lobbying against the bill but not the small businesspeople whom they are supposedly protecting. Agree 100% with Fred and Chris here.
http://www.victusspiritus.com/ Mark Essel

Tax laws are needlessly complicated, with the ultimate benefactor a larger segment of the workforce that has to wrestle with gaming it. I just asked @dpinsen for an non-financial translation of a somewhat related Forbes article about revenue declaration and taxation (iPad isn't letting me paste the link, but it's the June 3rd Forbes article covering big 6 banks).
sheynkman

Chris, I totally agree with you that carried interest should be treated and taxed as regular income.
However, Steve Schwarzman spends $400 on crabs not because the tax system permits him to do so, but because he can afford to do so. And more power to him. With higher taxes, I am sure his dining habits won't change dramatically.
Finger pointing at the “rich” is the kind of populist demagoguery that will alienate rational (sometime wealthy) supporters of the correct course of action you are advocating. Your argument that taxation should be fair is valid. The insinuation that people eating $400 crabs are somehow empowered by the moneyed elite who takes from the poor and gives to the rich is not.
Running for office ?
http://www.rre.com jdrive

I have posted a detailed response to why I think a lot of this discussion is wrong-headed (http://bit.ly/ayouex). Will paste the text below…

Populist blather is approaching a high-water mark, fueling a vitriolic debate around the Carried Interest tax 'reform' debate, as demonstrated thoroughly over at Chris Dixon's blog. It can feel good to go off on extreme examples like Steve Schwartzman eating $400 crabs, but it's important to think through what will really happen if this legislation actually becomes law.

Tax policy as it relates to finance and investment activities in the U.S. has as its primary goal the provision of incentives / disincentives based on 'preferential' activities. It is about incentivising behavior, not some individualized and highly-debatable construct of 'fairness'. Preferential activities are defined as long-term investments that promote real GDP as opposed to short-term trading with zero-sum outcomes. As a nation we have decided the correct number is 365.

So, the question is, do we want to revise the incentives, and if so, how? Changing the policy on 'carried interest' will, in fact — and with all due respect to my friend Fred Wilson's hypothesis — impact the flow of commitments into venture capital, private equity, leveraged buyouts, oil & gas, real estate, and just about every other partnership-based investment alternative out there. This will happen at least two ways…

First, these asset classes will be less profitable. Why? Because some, or perhaps even most of these newly-imposed 'costs' will be shared by the limited partners, reducing total returns for them — and their respective asset classes — as a group. It is simply naive to believe that only GP's will be affected. This will spark an exercise in reallocation analyses, and a flight to 'perceived' quality for those dollars that remain committed.

Here's what you will end up with… Fewer, larger 'marquis' firms with more pricing power, synthetic 'structures' that echo current LP economics but somewhat divorce term enforcement (more on this below), and tougher terms for entrepreneurs (The mid-range firms with only moderate pricing power will be most at risk, yet it is precisely this group that creates the competitive dynamic that startup companies have enjoyed in recent years).

Second, fund mangers will come up with creative structures (never forget the laws of unintended consequences, Idealism's frequently-fatal flaw) that traverse legal roadblocks while dissaligning shared incentives within the core investment activity. In other words, 'carried interest' will go away, replaced by some form of partner-based ownership in a given company (most likely same as common stock, only with voting rights on a deal-by-deal basis. Now, take a moment to think about that… and then think about future financing events, board representation, even deal selection – and the inherent conflicts of interest therein. Turning a performance compensation mechanism into an owned option difficult to subjugate to clawback will certainly not be in the interests of either startup companies or LP's (or the pensioners, endowments etc., that comprise them.

In sum, reducing the normalized return differential between common alternative asset classes and ordinary market investing – and thus altering the perceived risk-profile – will have real dollar consequences, make no mistake. Think you dislike hedgies now? Wait until a quarter of alternative assets pour into their coffers.

Moreover, it will significantly alter deal structures creating further chasms between funders and founders. And by the way, at least in the last ten years (as it relates to VC anyway) had this Bill been in effect, your US Gov tax bounty would have rounded to, um, essentially zero.

Couple of other points on this Carried Interest tax question….

1) As for Carried Interest being a 'fee', it's a performance override (and in no way definable as 'revenue'). Any payment — performance-based or otherwise — is ultimately 'describable' as a fee. The question isn't the nomenclature, it's in the certainty and timeliness of the payment, and the underlying asset that generated it. If it's under 365, then it's short-term. If it's directly attributable to the increase in value of a long-term asset, that's materially different than a tip for a job well-done.

2) Every successful VC I know could earn a multiple of their current salaries in other (and not necessarily so different) businesses; they choose to trade off substantially lower current economics (about 5:1 by my calculation) for even higher future earnings potential. But that's just what it is…. potential. Implicit in this contract is a larger piece of the pie and a cap gains tax-rate on value-creation in exchange for the assumption of this risk. Take away the tax benefit and VC's will be more risk-averse, not less. It is also ridiculous to suggest that people will stay in venture capital 'because they love it' despite substantially-diminished economics. Seriously?

3) As has been pointed out by others like Jeff Bussgang, quite a few of us in this business are ourselves entrepreneurs, having built successful, long-term venture capital businesses. We risked our capital, security and futures to chart our own course. But VC firms do not have exit opportunities like the startups in which they invest. We know that going in, so it's okay as long as alternative paths to wealth creation remain. You can count on two hands the number of firms that have sold or gone public since the dawn of this industry some fifty years ago — and on one hand the number that have actually been successful at it. That's maybe half a percent; a much, much lower transaction rate than startup companies enjoy.

In the end, I prefer a system that rewards long-term value creation over the casino that is Wall Street any day. And my viewpoint may surprise you, in that I, too, believe that there is a difference between investing a dollar from my own pocket versus a dollar managed that came out of yours. Which is why I actually think the long-term gain code should be revised down, to 10% for a principal's money, 20% for OPM override earned beyond a 12-month period (up from 15% today), and then the rest at short-term rates. This in my view achieves the all-important goal of delivering proper incentives for long-term investment over short while being, in my view, an obviously more 'fair' system. Remember, the startup company doesn't care from whose actual pocket it's long term dollars came. Nor does our economy.

VC-as-bogeyman is a popular meme at the moment, and I can't say it isn't somewhat justified. That said, babies and bathwater come to mind, and, unfortunately, heart-felt but unexamined populism rarely leads to better policy. It's not supposed to; rather, it's highest and best use is to stir debate. The current carried interest Bill will do little more than hurt the startup ecosystem while raising a de minimis amount of tax revenue.

http://bsiscovick.tumblr.com/ bsiscovick

I don't agree with your conclusions, but I really appreciate this post.

This issue is far from black and white, and reasonable, intelligent and 'fair' people can disagree. Over simplifying the issue as greedy vs compassionate/generous is counter productive.

But at the end of the day, my intuition tells me something different than yours – while I'm sure there will be consequences to a tax code change (there always are), the benefits here seem to outweigh the costs IMHO.

http://www.rre.com jdrive

Completely agree that we need tax reform, and I certainly get the desire to soak the fat cats that got us into this mess. Personally, I'm waiting for the perp-walks on Wall Street – like lots of other people. I actually suggest higher taxes in my post – on folks just like me. But if we are going to do it, then let's get real about change. VC is different than any other alternative asset class; it exists on the left side of Schumpeter's Curve (meaning actual asset value creation instead of redistribution of value, or value destruction). This is something I think we want to encourage. As for fairness, try this: how about we alter the AMT to include any amount over some threshold must be taxed at a full rate, no matter the source. While we're at it, I think we should actually return to the 90% tax rates of yore over some amount, as I don't believe anyone should ever reach ten digits, much less pass it down to their offspring.

Here's the thing… Are we trying to punish people (in which case, let's punish the right people); are we trying to raise taxes to pay for stuff (then let's actually do that, like with a shift to consumption taxation); or are we trying to define fairness (in which case let's completely redraw the lines). My read of the current Bill is it accomplishes none of these objectives.

Pete

If fairness is the desired outcome, why not just index the tax rates of capital gains in the same fashion as ordinary income (but with a different rate schedule)? Then CGs could be taxed uniformly regardless of how they are obtained. It seems the genesis of this shitstorm was really the PE and HF guys making off with billion dollar paydays taxed as LTCG. If capital gains taxes are indexed, then the small value creators get the breaks while the masters of the universe will have to part with a bigger proportion. And it would be interesting to see what would happen if the first, say, $100K of LTCGs each year were taxed at zero and the marginal rates rose from there.
http://twitter.com/mediainvestors Ted Carroll

I’ll propose a 100 percent tax on any and all income generated by the investment management of risk capital. In fact maybe we should all manage our firm’s out of jails constructed with “stimulus” borrowings and operated by the new flock of tax and spend fairness police. Here’s our real opportunity to out Europe Europe itself.
http://technbiz.blogspot.com paramendra

Crabs can be a powerful metaphor. Who would have thought?
Healy_Jones

A few days ago I tried to see if the change in long term capital gains rate impacted new VC fund formation, but I couldn't see any actual correlation. My thesis was that higher taxes would have decreased people's desires to start new funds (and find LP's would buy part of the GP) but I couldn't see any connection. http://www.startable.com/2010/05/24/carried-int…

I think that the macro-economic environment seems to be the major driver in venture capital fund formation.
Alessandro Piol

Chris, this post has already generated a lot of good debate and I don’t mean to beat a dead horse, but a year ago, in one of your posts (“The other problem with venture capital: management fees”) you said the following: “I fully support carry fees – it is very similar to equity in a startup. VC’s should get paid when they make money for their investors.”

I couldn’t agree with you more: carry is like common shares that entrepreneurs buy at a nominal price. In a venture capital fund, it is capital that is “loaned” to the General Partners to invest in companies. The GPs have to give back the capital and can keep the profits, which should be taxed at the appropriate capital gains rate (short-term or long-term), just like the common shares of the entrepreneur.

What made you change your mind?

To be clear, I tend to side more with my friend Jim Robinson’s position and less with my friend Fred Wilson’s on this topic. I believe that the proposed changes will have unintended consequences. We live in a nation with many creative lawyers, and the folks who make astronomical amounts of money (large PE funds and hedge funds) will find ways to restructure their activities and get around the extra taxation.

The category that will get hurt is going to be the small venture capitalists, the ones who don’t make a lot of money off their management fees, and who work hard to foster company creation and seek long term success. These investors will be tempted to raise larger pools of capital to generate more fees (management fees would now be taxed like carry, after all) and will as a consequence invest only in larger deals. This is the wrong incentive, in my opinion.

The right way to do this would be to adopt a finer filter. Why not tax where the money is, and not risk breaking what has proven to work. Tax the larger funds but leave the smaller funds alone. This will have the positive “unintended” consequence to create an incentive for smaller fund formation, to invest in smaller companies and be very motivated to create long-term success.
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http://www.graduatetutor.com Senith MBA tutor

Very fair. Most people dont have the heart to say this (especially if it will increase your tax bill!)
http://nextparadigms.com Lucian Armasu

You socialist! No, I'm just kidding

I think everyone should pay the same tax rates. This means I wouldn't agree with the reverse version either: people with smaller salaries and such paying less tax than those with bigger ones. That leads to lazyness in the grand scheme of things, because then you're not motivated to earn more, so the resulting growth of the economy should be lower.
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Chris Dixon