April 15, 2008 / 10:54 PM / in 11 years

NYC hedge fund profits show tax system flaw -study

NEW YORK, April 15 (Reuters) - New York City hedge funds earned $20 billion to $39 billion last year, far outstripping the profits of Wall Street banks and demonstrating how outdated the city’s tax system risks becoming, a new study said on Tuesday.

The Fiscal Policy Institute, the New York-based think-tank that issued the report, wants hedge funds and their private equity brethren to pay higher taxes, echoing a call by some Congressional representatives.

Last year was an exceptionally miserable one for the banks and brokerages that make Manhattan a global money center and underpin the city’s economy.

New York state Comptroller Thomas DiNapoli has estimated that Wall Street banks and brokerages in 2007 only earned about $2.8 billion. That is the worst result since 1994.

Though Mayor Michael Bloomberg says stricter regulations and stiffer taxes could drive financiers to other global capitals, the Fiscal Policy Institute disagreed.

The institute wants hedge funds and private equity firms to be subject to the city’s unincorporated business tax, just like small businesses, independent contractors and freelancers.

“In view of New York’s historic income polarization — the greatest in the nation — taxing the compensation of a private equity managing partner that can run into tens of millions of dollars and higher on the same basis as the business income of a smaller business owner seems like an uncontrovertible and overdue tax change,” said the institute.

New York City could generate another $165 million to $225 million in revenue a year from hedge funds and private equity firms if they had to pay the unincorporated business tax on carried interest.

Carried interest is usually 20 percent of the profits produced by the limited partners’ pooled investment.

Though fees earned by the funds’ managing partners are currently taxed, the carried interest is exempt because these people already have paid income taxes on their investments.

Even with a higher tax burden, the city’s 29 billionaires who made their fortunes from hedge funds or private equity firms would remain here due to New York’s “unsurpassed attraction as a place to conduct financial service business and as a desirable residence for individuals with very high incomes,” the study said.

The study cited Forbes magazine for its data on billionaires.

A mayoral spokesman had no immediate comment. The proposed tax change would require state approval.

Earlier this month Republican legislators and Democratic Gov. David Paterson rejected a Democrat plan for a higher income tax on millionaires.

The city now has 11 of the world’s largest private equity firms and 13 of the top performing hedge funds, the report said. The unincorporated business tax rate is 4 percent, but the study said hedge funds and private equity firms likely would only pay about a 2 percent rate.

They firms could deduct local business taxes from their federal tax returns and would get a “generous” 23 percent credit against personal incomes taxes they pay the city, the study said.

Though several private equity firms hit rough spots when bank loans withered, these firms earned an estimated $3.1 billion to $4.5 billion, the report said.

While many Wall Street firms saw their profits take a beating due to soured investments in risky subprime mortgages, winning hedge funds benefited by betting against the sector.

“Some hedge funds profited from betting against subprime mortgage and other investments that began to plummet in 2007,” said the report. Money-winning bets on commodities and selling specific stocks short also enriched some hedge funds.

Short sales involve betting that a stock’s price will fall. (Editing by Leslie Adler)

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