This is not a political piece, per se, but rather an objective look at the likely employment effects the presidential election could have on the private equity wealth creation business.
Over the prior two decades, the private equity industry has grown much quicker than the overall growth in total employment, with private equity payrolls increasing by an estimated 93 percent from 1990 through the second quarter of 2012, while the overall economy only added about 22 percent to its payrolls.
The support the private equity industry provides to the overall productive economic base is not a given. It depends upon well known factors, such as expected profitability, interest rates, and the potential competitive synergies. In addition to these factors, the industry can be heavily affected by regulation and tax policy. The three main tax policy issues are:
- Capital gains;
- Carried interest; and
- Overall tax reform.
How could each of these factors affect private equity employment and which candidate could have the better plan?
The first is the relationship between the capital gains tax rate and the private equity industry employment growth is shown in the figure above. It seems pretty apparent that there’s a negative relationship between the two. The negative relationship holds even after adjusting for other economic factors. So, given that a higher capital gains tax rate is likely to decrease private equity employment, the question becomes how large of an effect could a tax rate of 20 percent have in comparison to a tax rate of 15 percent? In doing some econometric analysis, the answer comes out to a decrease in private equity employment of about 5,000, or about 15 percent. The decrease in direct private equity employment of 5,000 ignores the multiplier effects of the industry. Should these multiplier effects be included, the bottom line decrease in employment comes out to a decrease of 20,000 to 30,000. Because Romney is likely to be more favorable to the taxpayer on this capital gains issue, Romney wins this issue.
The second issue relates to carried interest. The thinking behind taxing carried interest as capital gains instead of as ordinary income is due to the nature of risk private equity investors take on in their line of business. With that said, if the taxation of carried interest is changed from long-term capital gains, which has a 15 percent tax rate, to ordinary income, which has a 35 percent maximum rate, the fiscal drag could reduce private equity employment by as much as 20 percent. Again, Romney appears to have the advantage on this issue, with Obama publicly stating his desire to tax carried interest as ordinary income.
The third issue is overall tax reform. There’s a lot of uncertainty out there, largely created by concern over Obama’s desire to increase taxes and Romney’s lack of specificity regarding tax policy. Overall, the differences largely appear to be Obama’s desire to increase taxes on higher income individuals versus Romney’s desire to reduce government expenditures before considering tax increases. The winner may depend upon the economic conditions under which each plan is materialized.
Overall, when it comes to private equity employment, Romney probably provides the preferable path to increased employment in the industry by at least 12,000 direct industry jobs and 30,000 to 40,000 total jobs, although it’s definitely not a given.
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