A day before Valentine’s Day, President Obama released his $3.8 trillion budget proposals for 2013. But there were no valentines in it for key sectors of the Fairfield County economy, including hedge funds, private equity firms and individuals making more than $250,000 a year, whose tax rates would go up – some of them by more than 100 percent – if the Obama proposals become law.
Connecticut politicians are not shy about attacking the proposals.
“This (budget) is going to be incredibly harmful to our region,” said Connecticut Republican Christopher Shays, a former member of Congress now running for the U.S. Senate.
In an interview, Shays made it clear that he views many of Obama’s tax proposals through the same critical prism as many of his GOP colleagues – the lack of offsetting spending cuts.
“Regretfully, when the president talks about a new tax, he is going to spend it,” Shays said. “Don’t talk about raising taxes if in the end it is just going to more spending.”
Instead of hiking taxes and spending them on government programs, Shays said he favors reining in entitlement costs and reducing government debt.
Linda McMahon, Shays’ opponent for the Republican Senate nomination,
also weighed in.
“While campaigning for the White House, the president promised to cut the deficit in half by the end of his first term,” McMahon said. “Today, he proposed a budget that spends over $1 trillion more than what government will take in next year. When families sit down to pay their bills each month, they know it’s just not smart to spend more than they are bringing in. Why can’t the professional politicians in Washington understand that?”
The two groups likely to be impacted the most are upper-income individuals and private partnerships, including hedge funds and private equity firms. Both are important stakeholders in Fairfield County’s economy.
In the budget, Obama introduced the “Buffett Rule,” which says that no household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. Its name is derived from Warren Buffet’s observation that his effective tax rate is lower than his secretary’s.
To achieve this, the budget document proposes that those making more than $1 million should pay at least 30 percent of their income in tax. It also proposes allowing some of the 2001 and 2003 Bush-era tax cuts to expire, specifically letting the lower tax rates expire for taxpayers with household income over $250,000 per year. The 36 percent and 39.6 percent brackets would be reinstated.
The expirations have been greeted with dismay by many in affluent Fairfield County, where $250,000 and even $1 million annual incomes are relatively commonplace.
Another change has the low-profile, super-rich hedge fund community up in arms: ending their preferred tax treatment.
Connecticut is a world-class hedge fund capital, ranking third behind New York and London as measured by the number of firms headquartered in the state.
Currently, hedge fund managers, private equity partners and other managers in private partnerships are able to pay a 15 percent capital gains rate on their labor income (known as carried interest). This tax loophole has long been criticized as inappropriate, because it allows hedge fund managers to pay a lower tax rate than other workers.
Obama proposes eliminating the loophole and taxing carried interest at ordinary income rates, which would more than double the tax rate on private partnerships like hedge funds and private equity firms.
“It’s not the closing of any ‘loophole’ – it is an end run around a fundamental principle of the tax code regarding the taxation of partnership interests,” says John A. Brunjes, a director of the Connecticut Hedge Fund Association and head of legislative and regulatory affairs.
Brunjes explains that hedge fund managers, like the managers of other types of private investment funds, are putting capital at risk in a way that could result in an entire loss, at least in theory.
Because of this, he says, “the tax code has historically accorded them special treatment in the form of a lower tax rate on their earnings from this activity. Taxing their payout at higher rates as if it were ordinary income from employment-type services is very unfair to someone who stakes it all by putting risk capital in the market.”
Not surprisingly, Brunjes’ opposition is echoed by the Managed Funds Association (MFA), the industry’s Washington, D.C.-based lobbying arm.
Changing the character of all carried interest income to ordinary income would create significant collateral effects, including an adverse impact on state and local tax laws, the MFA states on its website. The association adds that many hedge funds elect to be treated as a “trader” under the Internal Revenue Code, and as a result, their investments are treated on a marked-to-market basis and taxed at ordinary income rates.
Connecticut Democrats are taking a guarded stance. In particular, Gov. Dannel P. Malloy has been uncharacteristically silent on the issue of tax increases. Asked for a comment on Obama’s tax proposals, Malloy’s office emailed a statement that addressed economic revival, but not taxes.
“The governor is encouraged by President Obama’s call for bringing high-growth, high-demand industries to our communities,” the statement said, adding that Malloy “looks forward to working with (Obama) to make our state and the rest of our nation a leader in innovation and cutting-edge industries
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