WASHINGTON — Senate Democrats Tuesday weakened efforts to end a controversial Wall Street tax break, watering down a bid to raise taxes on managers of hedge funds, private-equity funds, venture capital firms and other business partnerships.
The Senate action retreated from a step taken last month by the House of Representatives, where lawmakers voted to get tough with Wall Street financiers, an apparent bow to election-year pressure from constituents outraged that some captains of finance were taxed at lower rates than their secretaries are.
Currently, managers of these investment funds are compensated with a share of the fund's profits, referred to as "carried interest." This compensation is taxed as a capital gain, and the capital gains tax is now 15 percent.
Senators scaled back the House plan to tax as "ordinary income" some 75 percent of the fund-income these managers receive. Instead, the Senate would trim the tax hit to 65 percent, and 55 percent for assets held longer than seven years.
In real-world terms, the Senate change means that fund managers most likely would fall into the top tax bracket for 65 percent of their compensation. The top bracket stands at 35 percent now, but absent a change by Congress would revert to 39.6 percent next year.
The Senate plan, part of an emergency spending and jobs bill, is expected to raise about $14.45 billion over a decade, some $3 billion less than the House version would. In both bills, the money would help pay for a series of economic aid programs, notably extended unemployment benefits and summer jobs for at-risk youth.
Congress wants to raise the tax to generate revenue to pay for new government spending when the federal deficit is at a record high. Many of the bill's provisions are considered emergencies, which is why most Democrats and some Republicans are willing to add to the deficit. In addition, extracting tax money from the wealthy is a popular way to appeal to voters.
Sen. Olympia Snowe of Maine, a centrist Republican, wants to see more deficit reduction and thought "some of these (fund-manager) earnings should definitely be treated as ordinary income."
Other senators said fairness is the issue.
"It's certainly unfair that a hedge fund manager never has to pay the same tax rate as a teacher or firefighter," said Sen. Claire McCaskill, D-Mo. "But then again, we want to continue to encourage the creation of capital investment."
The financial sector argued that's just what's at risk.
"The proposals will stifle innovation and the free flow of capital," said Scott Talbott, the chief lobbyist for the Financial Services Roundtable, which represents big financial firms. Money that could be reinvested would instead flow to government, their logic goes.
The National Venture Capital Association, whose members help finance start-up tech firms, welcomed the Senate retreat. Spokeswoman Emily Mendell described the Senate language as "moving in the right direction" because it made exceptions for longer-term investments.
While the change is designed to hit Wall Street, real estate partnerships would account for almost half the partnerships affected.
"According to the IRS, these real estate partnerships hold over $1.5 trillion of commercial real estate assets throughout America, including: rental housing, office buildings, shopping centers, medical facilities, hotels, senior housing and industrial properties," Jeffrey DeBoer, the president of the trade association The Real Estate Roundtable, said in a blog posting Tuesday. "The carried interest tax proposal would change the taxation of all these partnerships — for past and future investments."
From both the political left and right, some senators vowed to undo the compromise.
Asked if they'll succeed, Senate Finance Committee Chairman Max Baucus, D-Mont., who helped broker the deal, said, "My guess would be no."
But they'll try.
"If someone is making $15 an hour, it's taxed 100 percent as ordinary income," said Sen. Bernard Sanders, a Vermont independent, unhappy with the compromise. "Instead, we continue to have a tax system that's benefiting upper-income people."
Sen. Orrin Hatch, R-Utah, a senior Finance Committee member, opposes the Senate position for the opposite reason as Sanders.
"This is a mistake. It's a way of grabbing more taxes, and it could hurt a lot of companies," he said.
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