Gov. Dannel P. Malloy reacted warily Tuesday to state legislation to eliminate the “carried interest” tax break for Connecticut’s influential hedge fund managers, suggesting instead that the liberal sponsors press President Trump to keep his pledge to eliminate the tax benefit through federal action.
“I don’t think it’s in the best interest of Connecticut to lead that discussion, because we have employers who have large number of employees in our state,” Malloy said, referring to a hedge fund industry the governor has repeatedly called important to the state economy. “I just don’t think that’s an area we should stake out.”
Malloy was reacting to a coalition led by the union-funded Working Families Organization that says a bill co-sponsored by 35 state legislators could raise $535 million annually by imposing a 19 percent surcharge on “investment management service fees.” With more than $300 billion under management, Connecticut has the second-largest hedge fund industry in the U.S.
As a nod to fears that such a surcharge here might prompt hedge funds to move, the law would not take effect unless the competing states of Massachusetts, New Jersey and New York adopt similar legislation. The bill has not cleared its initial hurdle of being approved for a public hearing by the Finance, Revenue and Bonding Committee.
The governor, who commented on the legislation at an unrelated press conference, later clarified that he saw no need to put Connecticut at the center of the debate, given Trump’s promise.
“Let him do it,” Malloy said.
Lindsay Farrell, the executive director of the Working Families Organization, said she saw no chance that a Republican Congress would eliminate a provision that enables fund managers to pay a tax rate that’s roughly half what other wealthy salaried employees pay, even if Trump presses for passage.
“I’m not sure there is a way for him to do this by executive order,” Farrell said.
Some tax experts disagree, as Bloomberg recently reported, noting that carried interest is defined in IRS regulations, not federal law.
Carried interest is an ancient term that goes back to an incentive paid to sailing captains for safely delivering cargo — 20 percent of the profits on the “carried product,” hence the term “carried interest.”
In the modern version, investors in private equity funds typically pay the managers 20 percent of whatever profits the funds return. The income is taxed as capital gains, not ordinary income, The maximum capital gains rate is 20 percent for an investment held for at least a year, compared to the top rate of 39.6 percent for ordinary income.
The 19 percent surcharge is meant to effectively tax the fees as ordinary income.
The Working Families and its allies, including the Patriotic Millionaires, a self-descried group of “high net worth Americans” who favor tax reform as one way to address income inequality, say the the premise behind a lower tax rate for capital gains is that the investor is bearing a risk making investments that grow the economy.
“Those people who manage other people’s money seem to have forgotten that they are not investing their capital. They’re simply advising their clients on how to invest their capital,” said Morris Pearl, chair of the Patriotic Millionaires. “They are in no way deserving of a special tax break meant to encourage long-term investment. They are no more investors than the accountants, the lawyers and, in fact, the cafeteria workers who work in their offices.”
Malloy has been protective of the financial services industry in general and hedge funds in particular as a source of high-paying jobs in Connecticut, primarily in Fairfield County. The state has 200 hedge funds, led by Bridgewater Associates of Westport, with $151 billion under management, according to the Connecticut Hedge Fund Association.
The Malloy administration has labored to deepen Bridgewater’s ties to Connecticut, pledging $30 million in tax credits over 10 years and offered a $22 million package of loans and grants in return for the company retaining 1,402 jobs and creating 750 new jobs by the end of 2021.
The Hedge Fund Industry of Connecticut has warned against doing anything that would eliminate the tax advantages the state now has over New York and New Jersey.
Charles Khan of Hedge Clippers, a group funded by labor and others to fight what it says is the outsized political influence of hedge funds, said the multi-state compact proposed in the legislation is intended to keep hedge funds from playing one northeastern state against another.
“The capital’s not going to go anywhere,” he said.
Rep. Robyn Porter, D-New Haven, said Connecticut needs to look for new sources of revenue, because it will be impossible to close a projected $1.5 billion shortfall in the coming fiscal year solely through spending cuts.
Bruce McGuire, the founder and president of the association, could not be reached for comment.