Struggling to raise revenue for recession-hit New York in the face of a gaping budget shortfall, the New York State Legislature proposed in June a plan to collect additional income taxes from hedge fund managers with offices located in New York, but who live outside the state, by treating much of the compensation earned by these fund managers as ordinary income. However, this plan may have fallen by the wayside in the face of fierce industry criticism echoed by New York City Mayor Mike Bloomberg.
New York’s Democratic-led Assembly was originally expected to approve the proposed tax hikes on hedge fund managers on Thursday July 1 as part of a proposed bill to raise roughly $1 billion and help close a $9.2 billion deficit. However, New York Governor David Paterson said in a radio interview on Thursday that the plan might deserve reconsideration. Later in the day the New York Senate put off any vote on the $1 billion package of tax and revenue measures, although it is the last piece of the state’s almost $136 billion budget, which is three months late.
Many fund managers are paid a flat management fee of 2 percent of assets, plus — as a performance incentive — as much as 20 percent of any profits they generate. The latter amount – known as “carried interest” – has been taxed federally at a rate of 15 percent because it is treated as a capital gain, rather than as ordinary income, which is subject to rates as high as 35 percent.
At the federal tax level Democratic leaders in Congress have tried unsuccessfully three times this year to reclassify carried interest payments as compensation to be taxed at ordinary income rates. But in the face of unilateral Republican opposition, the Democratic proposal failed each time (most recently last week as the proposal collapsed with a bill extending unemployment benefits). Thus for the moment investment managers will continue to pay the 15 percent federal capital gains tax on their carried interest profits. New York residents, however, pay ordinary income taxes on this income. The proposed New York plan would extend this treatment to non-New York residents with offices located inside the state.
Industry opposition to the New York tax proposal has been swift and fierce, with tax lawyers and representatives of investment firms arguing that fund managers would be taxed twice on the same earnings, and warning that those who already live in places like Greenwich, Conn., or Summit, N.J., would decide to move their businesses out of New York and work closer to home. Mayor Bloomberg recently echoed the latter concern when asked to comment on the new plan by the New York Observer:
“I think it’s the best thing that ever happened to Connecticut,” responded Bloomberg. “I can’t imagine why every hedge fund won’t pick up tomorrow and leave.”
Mayor Bloomberg appears to have spoken directly to Governor Patterson on Wednesday, and the mayor’s concerns did not fall on deaf ears. The following day in an interview with WOR radio, Governor Patterson said:
“It might be far more responsible for us to revisit that issue, particularly about the hedge fund managers, because according to Mayor Bloomberg, and he told me this yesterday, all they have to do is basically change their addresses.”
On its end Connecticut appears poised and ready to welcome New York hedge funds. On Wednesday Connecticut governor M. Jodi Rell, reigniting the rivalry between the two states over competition for the hedge fund industry, sent a letter to New York Hedge Fund Roundtable President Timothy Selby, offering her state’s services to New York hedge fund managers who relocate. In the letter, Governor Rell praised what she called Connecticut’s more “enlightened” approach to job creation and invited Selby and other managers to make Connecticut their new home, offering the services of the state’s economic development professionals to help the managers find offices, homes and schools.