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Citizens Union

Where the City Can Find $200 Million

The economic mood is sour. Unemployment is up. The cost of gas is up, food is up and healthcare is up. One thing that is down, though, is New York City’s budget outlook. The city budget approved last month cuts money for senior centers, youth programs and other services. And officials warn this might only be the beginning.

That is what happens in a recession. We have to make some painful cuts. But we also have to have the nerve to talk about how to bring in more revenue. It’s the same as when you hit a financial crisis in your household budget. You make some cuts, but you also figure out how to bring in more income. That is why lots of New Yorkers work two jobs.

During the recent budget negotiations, the mayor wanted to suspend rollbacks in the property tax. The City Council reportedly preferred an increase to the hotel tax. Both proposals pose real problems. The first hurts working families and the second hits tourism, critical for the local economy. Though we avoided both taxes in the budget that just passed, they remain on the table for the foreseeable future.

What if, instead, we could raise money to save vital programs by simultaneously bringing fairness back to the city tax code? What if we could close an appallingly unfair loophole for the wealthiest New Yorkers and, according to the Fiscal Policy Institute, make more than $200 million in revenue appear to plug the budget gap?

Well, we can.

A Loophole For Hedge Funds

State Assemblymember Micah Kellner has introduced legislation that would change the city’s Unincorporated Business Tax to eliminate an unfair exemption for private equity and hedge fund managers. This loophole allows some the richest people in the city to avoid paying business income taxes on a major source of income called “carried interest” – fees charged by managers of investment firms based on the returns they deliver to investors.

Most economists agree that carried interest really is a fee, and therefore should not be eligible for preferential tax treatment. At the federal level, carried interest is treated as a capital gain – taxed at 15 percent -- rather than as personal income, which would be taxed at 35 percent. (Citizens for Tax Justice, a national advocacy group, has assembled an information sheet on the tax break.)

Here in New York, the carried interest exemption completely prevents billions in investment profits from being taxed at all.

For years, this loophole went largely unnoticed. But the explosion of private equity firms and their unique structure has made this an issue. As the industry has grown by leaps and bounds, the amount of carried interest and the revenues that could be reaped from it has grown exorbitantly. Closing this loophole would raise $25 billion in taxes nationally over the next 10 years, according to Citizens for Tax Justice.

The Local Effects

One beneficiary of this loophole is New York financier Henry Kravis, whose massive private equity fund owns everything from Toys R Us to Sealy mattresses and lots more. His firm – Kohlberg, Kravis and Roberts – banks much of its profit on returns from investors. Kravis, a billionaire many times over, can certainly afford to pay his fair share.

Instead, much of his firm’s income is exempt from the city’s business income taxes. The result: Millions of New York taxpayers with middle-class incomes pick up the slack while also losing government services to budget cuts. To level the playing field somewhat, Kellner's measure would close this loophole and tax Kohlberg, Kravis and Roberts' profits at a 4 percent rate.

An effort to close the federal loophole passed the House last year, but not the Senate. Barack Obama favors closing it, John McCain opposes such a move. So there’s a chance something will happen on this in Washington next year.

New York, though, should not wait to act on its own. For starters, the City Council through a home rule measure could direct the state (as it did with congestion pricing) to act on its behalf and tax the fees. A majority of City Council members are on record in favor of closing the “Rich Guy” loophole.

Unless there is a special session, the legislature will not get to act on Kellner's bill this year. But with the city and state both looking at budget gaps over the next several years, this is an issue that isn't going away.

It is not often that you can raise money for the public coffers by doing the right thing. This is most certainly one of those times. We cannot let it pass us by. We are out of time and money. The mayor and governor must act to close this loophole, or the rich in New York will just continue to get richer as the rest of us suffer.

Dan Cantor is the executive director of the Working Families Party 

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