Best Congress Money Can Buy: Ultra-Wealthy Keep a Sick Tax Loophole

Congratulations, John Paulson! Bloomberg News, after combing through the records of 2,000 hedge funds with at least $100 million each in assets, has just named you 2007's top-earning private investment fund manager, through this year's first nine months.

Paulson's Paulson & Co. family of hedge funds, says Bloomberg, has pulled in $2.69 billion in performance fees so far this year.

Now here's the best part -- for Paulson and Paolo Pellegrini, his co-manager at Paulson & Co. All those fee billions will get taxed, come April 15, at just a 15 percent rate, not the 35 percent rate that applies to ordinary high income.

How's that possible? Simple. The U.S. tax code currently sports a clever little loophole that lets hedge and private equity fund kingpins define their "performance" pay as a capital gain.

In 2007, this loophole will save masters of the universe at Paulson & Co. $538 million -- over half a billion dollars -- off their taxes.

Paulson and Pellegrini won't be the only private investment fund superstars benefiting big-time from what's usually called the "carried interest" loophole. Philip Falcone of Harbinger Capital Partners and Jim Simons of Renaissance Technologies LLC have each collected over $1 billion in incentive fees so far this year.

Billionaires like these, investor guru Warren Buffett observed last month, will all pay federal taxes on their 2007 earnings at a lower tax rate than their receptionists.

Now here's the amazing part: The Senate of the United States does not care.

Last month, the House of Representatives passed legislation that ends the "carried interest" loophole and uses the proceeds from that move to help fund tax relief for middle-class taxpayers.

Last week, Senate majority leader Harry Reid could not round up enough votes to stop a GOP filibuster to kill the House bill. That legislation now has no chance of passing the Senate this year.

The main reason: The private investment fund industry has mounted an unprecedented lobbying blitz against ending the "carried interest" loophole.

Private investment funds, says the Center for Responsible Politics, spent only $3.7 million on lobbying in all of 2006. They spent $8 million in the first six months of this year alone -- and also upped their political contributions to federal candidates and party committees from $1.6 million in 2005 and 2006 combined to $11.7 million in this year's first nine months.

"There's been a gigantic effort on the part of Wall Street to lobby this issue," Senator Charles Grassley from Iowa told the Washington Post last week. "They've hired every Tom, Dick and Harry, and they've put on every former Grassley staffer they could. It has had an impact."

That impact will ensure hedge and private equity fund managers like John Paulson still another year of windfall tax breaks. But those tax savings, at least in Paulson's case, may end up having some redeeming social value.

Paulson has earmarked $15 million of his investment fund earnings for a nonprofit that's helping victims of the subprime mortgage collapse. That's eminently thoughtful of him. Paulson, after all, owes most of his 2007 success to investment bets he placed on the subprime mortgage market.

On the other hand, this $15 million donation by Paulson -- who lives in a five-story, $14.7-million townhouse on Manhattan's East Side -- equals just over half of 1 percent of what Paulson & Co. has cleared this year in hedge fund performance fees.

Let's hope he tips better.