Debating Private Equity: What Are We Talking About?

The Obama campaign’s attacks on Mitt Romney’s record at Bain Capital make perfect sense to me as basically a character attack. Smart ambitious people choose different lines of work for different reasons, and it takes a certain kind of ruthlessness to decide to spend your life doing leverage buyouts and initiating mass layoffs. I don’t find this debate particularly enlightening but character debates are an inevitable element of campaigning. But last night on twitter, Chris Hayes suggested that we were actually having an important national debate about the role of private equity in the American economy.

From where I sit, what we’ve actually been having is an extremely confused and confusing debate that has almost no content beyond affect.

But let’s try to bring some substance to the debate. Noah Smith has an interesting laudatory post about private equity, suggesting a lack of leveraged buyouts explains some of Japan’s problems, but the specific policy content is to disparage the huge legal tools the Japanese legal system gives incumbent managers to prevent their firms from being bought by outsiders. By contrast, Eileen Appelbaum and Rosemary Batt did a very disparaging policy report (PDF) for the Center for Economic and Policy Research back in February. They conclude that based on this that there ought to be more economy-wide limits on the permissable degree of leverage, and also that we ought to reduce the tax arbitrage opportunity represented by the deductibility of debt. They don’t advocate adopting Japan-style rules to protect incumbent managers, and Smith specifically sites the tax arbitrage issue as a real one that should be curbed. Which is to say that Smith, who likes private equity, and Appelbaum and Batt who dislike it don’t appear to have any policy disagreements.

And it’s important to note that the issues we’re debating have only an incidental relationship to private equity. The option of increasing shareholder return by exploiting tax arbitrage to increase leverage is a tactic that was arguably pioneered by private equity managers, but it’s available to everyone. The relevant feature of the US tax code wouldn’t vanish if we eliminated private equity firms, and private equity firms wouldn’t vanish (though they might diminish in number) if we changed the tax code. Another real private equity policy issue is the question of whether it makes sense for the managers of PE firms to pay the capital gains income tax rate when their income is clearly labor compensation. The correct answer to that is “no.” However to make the case you hardly need to argue that PE is some uniquely evil industry. The point is merely that it’s not such a uniquely beneficial industry that there should be a special tax subsidy to encourage people to try to enter it rather than some other money-making scheme.

The interesting thing is that I think that if pundits sort of took a deep breath and started talking specifics they would find that most of these points aren’t very controversial. The politics of actually doing tax reform are famously impossible for well-known reasons, but there isn’t a real conceptual void here.