Obama fund plan more sizzle than steak

Taxing "carried interest" has long been a hot-button issue in the $1.4 trillion (980 million pounds) hedge fund and $2.5 trillion private equity industries and it exploded on Thursday as Obama's new budget proposes raising about $24 billion over ten years by eliminating what has been called the "carried interest" tax loophole.

Carried interest, or carry, is the cut of profits -- typically 20 percent -- that private equity and hedge fund firms' partners keep as compensation.

For years, they have had to pay only the 15 percent long-term capital-gains tax rate on carry instead of the roughly 35 percent tax for ordinary income.

"There is a very strong argument to be made that the 20 percent (managers charge in performance fees) is real income but it is a moot point today because it will take the funds years to get back to their high water marks," said Cornelius Hurley, director of Boston University School of Law's Morin Centre for Banking and Financial Law.

Managers and industry experts note, with some irony, that the plan is being announced at a time these once high-flying fund firms are not earning much money and years before the proposal is set to take effect in 2011.

Facing tumbling financial markets, private equity funds have been making large writedowns on their portfolios, while many hedge funds suffer heavy losses. This means their managers are nowhere close to earning their lavish 20 percent performance fees.

"Proposing the plan now, creates more noise now than is probably necessary," Hurley said.

NOT A DONE DEAL

Looking ahead to the day such a proposal might have real teeth, experts say that raising the carry would be a hit for private equity and hedge fund firms but would not kill the industry.