You don’t have to be a stone-throwing, window-smashing anti-capitalist to enjoy the drubbing inflicted on the private equity industry by the Treasury Select Committee this week. I’m an enthusiastic supporter of private equity and believe that it has made a huge contribution to the competitiveness of British companies and the success of the City. I also think some of the Labour MPs who led the attack on the industry are boorish, show-boating economic illiterates motivated by envy and spite. Even so, it’s hard to deny that private equity is only getting a richly deserved comeuppance for its failure to recognise the legitimate public interest in what it does and its insistence on trying to cling on to its tax perks.
Indeed, private equity might have avoided this crisis had it simply put its hand up weeks ago and conceded that the special tax treatment it gets on its carried interest – effectively, its performance fees – is too generous and should be reviewed. But greed got the better of the industry. As a result of a deal with the Treasury, private equity is allowed to treat its performance fees as capital gains, rather than income, which means it pays 10% tax or less, rather than 41% like everyone else. A few enlightened figures, such as Nick Ferguson, chairman of SVG Capital, and Sir Ronald Cohen, former chairman of Apax, recognised the futility of trying to hang on to this perk. But most didn’t see the danger. Even after last week’s debacle, heavyweights like Guy Hands and Jon Moulton won’t give up.
The arguments used to defend this perk are almost entirely bogus. One member of the Select Committee told me what really got up their noses was that the industry treated them like idiots, resorting to obfuscation and scaremongering. For example, I don’t know anyone in the industry who privately believes that people would move offshore if the tax perk is removed. The really juicy perk was only introduced in 2003, when taper relief was cut to its current rate. Yet the industry was well-established in London by then.
Similarly, it’s nonsense to suggest the supply of venture capital will dry up if those working in the industry have to pay the same tax rate as the rest of us. Changing the tax rules won’t change the supply of capital, nor the supply of entrepreneurs, since they will still be eligible for taper relief, a senior venture capitalist admitted to me this week.
At the margin, taxing performance fees as income might make venture capital a less attractive career for some. But venture capitalists would still earn substantially more than bus drivers and I don’t see any shortage of them. Besides, the tax system shouldn’t favour one form of risk-taking over another, since that is what leads to misallocation of capital.
The longer the tax row continues, the more it damages everyone. Private equity will find it harder to do deals, which will hurt all investors as bid speculation is what is keeping share prices high. The row could hit investors in other ways. The day before one of its senior executives was due to appear before the Treasury committee, KKR capitulated to the demands of Boots’ pension trustees, who had been demanding a huge cash injection into the pension fund following the recent buyout of the chain. This precedent could mean shareholders will get less in future takeovers of firms with pension deficits. The buyout barons now claim to have woken up to the dangers and have said they will give up their tax break. But the legacy of this row is unlikely to go away.
City boys are rooting for Ed Balls
When Gordon Brown takes over as Prime Minister next week, the City’s eyes will be on who succeeds him as Chancellor. The bookies have installed Alastair Darling, current Trade & Industry secretary, as the runaway favourite. This dour Scottish lawyer is said to be close to Brown and a safe pair of hands. It’s true that in a decade of this government, I can’t think of a single memorable thing he has said or done. If that’s what counts as success in politics, he’s the man.
But I know who the City would like to see get the job. Ed Balls has won a huge fan club in the Square Mile during his stint as Economic Secretary to the Treasury. The City was impressed by his defence of London’s Alternative Investment Market, when its regulatory standards were attacked by envious US rivals and policymakers; they admired his willingness to speak up for private equity. They like the way he has defended the City in Brussels against the eurocrats. And they remember his role in scotching Blair’s plan to take us into the euro.
People say he is too young, or hasn’t been an MP long enough and that he’s not a good public performer. But Brown owes him for ten years of loyal service. And by making Balls Chancellor, Brown would send a clear signal to the City that he has no truck with the destructive Old Labour politics of envy that we’ve heard during the recent deputy leadership campaign. When I heard him speak the other day, I was impressed by what he said and the way that he said it. The bookies have him as a 7/1 outsider. I hope they’re wrong.
Simon Nixon is executive editor of Breakingviews.com
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