A study tracking the correlation between tax rates and private equity investment shows that the pending proposal to more than double the tax rate on “carried interest” profits earned by investment partnerships could reduce private equity investment in the US by USD7bn to USD27bn a year, with an accompanying loss of thousands of jobs.
The Private Equity Council study also concludes that the rate increase could reduce the overall value of the nation’s commercial real estate assets and in turn contribute to an increase in commercial mortgage default rates.
“This data is consistent over two decades and confirms that tax increases reduce private equity investment activity and that the proposed 157 per cent tax increase on investment partnerships would have a harmful effect on the economy, the recovery, and job creation,” says PEC president Douglas Lowenstein. “We have said throughout this debate that private equity will continue, but this will have an adverse economic impact.”
The PEC study analysed reported equity invested in US businesses by all types of private equity partnerships – venture capital, buyout and growth capital – between 1980 and 2009, using data provided by ThomsonReuters. During the past 30 years, annual invested equity rose from USD723m in 1980 to USD49bn in 2009. The record year for investing was 2000, when USD137bn was invested in more than 7,000 businesses.
Sizeable changes to the effective tax rate on private equity investment have been enacted on three occasions in the past 30 years: 1986, 1997, and 2003. In each of these cases, an increase in the effective tax rate reduced the growth of private equity investment and a cut in the tax rate stimulated investment, as measured in the four years before and after the rate change.
To isolate the marginal effect of tax rates on equity investment, the study excluded the effects of credit markets, the health of the overall economy and other policy changes on the investment data.
The study adopted a conservative approach to measure the investment impact of the proposed tax increase, using two separate methodologies. The first methodology measures the impact of the tax increase on total dollars invested. Using this approach, a one percentage point increase in the effective tax rate on private equity investment is associated with a USD1.8bn decline in annual private equity investment, holding all other factors constant.
Thus, the pending 14.7 percentage point increase in the tax rate – from 23.8 per cent (in 2013) to 38.5 per cent as proposed by the House – would result in an annual decline of USD27bn in private equity investment.
The second methodology calculates that every percentage point increase in the marginal tax rate would result in a 1.07 per cent annual decline in private equity investment, holding all other factors constant. Based on 2009 investment – when investment was relatively low – that would result in an annual investment reduction of USD7.7bn.