Tax Hikes On Private Equity, Stock Buybacks Could Threaten Economy

Tax policy is a key driver of the economy and the financial markets. We've written how tax policy is at the center of the housing boom and the trade deficit (or capital account surplus).

We try to follow tax policy as closely as any economic indicator, or more so. In the past two weeks there have been two key tax developments, which stand to threaten the economy. These changes target two of the primary drivers of the stock market: private equity buyouts and stock buybacks. It has been widely reported that Congress is targeting private equity by increasing the applicable tax rates.

The great question remains about the impact higher taxes on partnerships could have on all investors in real estate, commodities, and other asset classes that use the partnership structure with a carried interest. These structures are ubiquitous among the mass affluent and any tax change impacting these structures will result in massive amounts of revaluations and loss of personal wealth.

On the other hand, it has gone virtually unreported that the IRS will no longer allow corporations to buy back stock with profits from their foreign subsidiaries without paying repatriation taxes. Putting aside the blatantly unconstitutional nature of these rule changes (were does the Constitution state that the IRS can raise your taxes?), this move by the IRS and Treasury is truly a market negative. It will shut off a significant source of capital that has been fueling record levels of stock repurchases.

I'll leave my analysis to these simple remarks. David Kotok at Cumberland Advisors has a great piece on both of these changes. If you didn't catch him this morning on SquawkBox, then definitely check out his article.

Comments

[Richie:]

This article has NO merit

2007 Jun 19 10:42 AM

[Nicholas Bogos:]

I agree with RAVERNON. The idea that the § 367 regs are unconstitutional is inane. So is the idea that changing the taxation of PE vehicles will cause massive economic dislocations. I'm a tax lawyer who has first-hand experience in this area, and the author doesn't know what he's talking about. We hear this kind of garbage from Cato, Heritage, AEI, and now the Mercatus Center at GWU. Nothing but apologists for Paris Hilton and Steve Schwarzman.

As for Kotak, he doesn't know what he's talking about. He blames the 1987 stock market crash on Congress limiting interest deductions in LBOs. Nonsense. The '87 crash started in Japan, and Japanese companies did NOT use the structure. Then it rolled over to NY and thence to Europe, and Europeans did not use that structure in their markets. I don't know what's Kotok's problem, but he needs to get back to economic reality.

2007 Jun 21 04:52 PM

[wixeywaxy:]

Both comments to your article above are from flakes. Your article is correct. Some people never saw a tax they didn't love, so long as it's someone else paying it. Typical of those with weak minds because the taxes foisted on business come back to bite us. All taxation is eventually paid for by the consumer as a cost of producing those goods and services we all use. The true tax is what government spends as Milton Friedman pointed out. If the spending isn't covered by taxes it's covered by devaluation of the currency. The bottom line is the direction of the system is, and has been, toward more taxation and greater complexity. In the end it's making us all poorer because government is the absolute worst and most inefficent provider of anything. Everthing they do is riddiled with stupid mismanagement, waste and corruption on a scale far worse than the private sector. Vic

2007 Jun 22 09:25 AM