I keep trying to explain economics to my wife. Yesterday she asked why partners at hedge funds and private equity firms shouldn't be taxed like the rest of us.
Steve: Lower tax rates for private-equity and hedge-fund partners benefit all Americans.
Judith: Says who?
S: Says Henry Kravis, the billionaire founder of a private equity firm.
J: Just how do tax breaks for private equity partners benefit all of us?
S: Kravis says the tax breaks create jobs.
J: So when a private equity firm buys a company they hire more people.
S: No. In fact, the first thing they do is lay off a bunch of people.
J: So how do they create jobs?
S: Steven Schwartzman, another billionaire private equity partner, spent $15 million on his 60th birthday party.
S: Think of all the jobs this creates for event planners, caterers, and celebrity chefs.
J: That makes up for all the people they fire?
S: You have to add in all the jobs they create in industries such as interior design, art consulting, and yacht construction.
J: I read that the top 25 people in the industry earned $10 billion last year. That is an average of $400 million each. Is it fair to tax them at 15 percent when people making 99.98 percent less pay 35 percent?
S: It's not a matter of fairness. It is a matter of incentives. Without a low tax rate these partners have little incentive to work. Why earn $400 million if, like everyone else, you have to give a third of it to the government?
J: Doesn't the average worker need the same incentive?
S: Not at all. The average worker already has great incentives, regardless of tax rate – if she does not work, she starves. But these hedge fund people are rich enough to retire. We need to provide extra tax incentives to keep them working.
J: The New York Times reported that in connection with selling their stock to the public, the partners of Blackstone, Steven Schwartzman's firm, will "get back about $200 million more in taxes than they paid initially." Is this fair?
S: Consider all the work they create for tax lawyers and accountants who have to set up $3.7 billion of goodwill, transfer it to a blocker corporation, amortize the goodwill over 15 years, and then deduct it from partner's earnings. Calling for higher taxes on such people is class warfare!
J: Why wasn't it class warfare when Bush reduced their taxes?
S: Because we need to reward them for taking risk.
J: Do private equity and hedge fund partners risk their own money?
S: Are you joking? These are smart people. They risk other people's money.
J: Why do they need additional tax incentives to risk other people's money?
S: Because they are risking their reputations. If they don't take home $340 million after tax, they might not be asked to join art museum boards. Curators would gush over Mr. Fund's "magnificent eye."
J: Do hedge fund art buyers have magnificent eyes?
S: No. They have magnificent wallets. But it would be unseemly at the museum's annual gala (this year's theme: "Homage to the Monied") for a curator to slaver, "Many people have a superb eye. What distinguishes Mr. Fund is his superb wallet. He will pay big bucks for any trendy work."
J: Why should we care if Mr. Fund receives praise for his superb eye?
S: Because it helps the economy. Suppose Mr. Hedge Fund sits on the Board of the Museum of Post-Contemporary Art. The curator advises him to buy some drek for $10 million. Then when MOPCA gives the artist a one-man show, the value of the Mr. Fund's artwork triples. The economy grows by $20 million. And no one pays any tax.
J: But how does that benefit anyone other than the curator and Mr. Fund?
S: You don't understand the economic theory of "trickle down." Trickle down is why George Bush was confident that we would all be better off if the rich paid less tax.
J: So now the rich pay less tax. What has happened?
S: The top 1 percent of the country is much better off; the bottom 90 percent is only slightly worse off, so Bush was right.
J: How so?
S: Everything is in place for "trickle down" to work. The rich have more money to trickle and there a lot more people below to get trickled on. It takes time for trickle down to work its magic.
J: How long does it take?
S: In France, the Bourbons tried it from 1589 until 1789. Two centuries wasn't quite long enough.