Seven Questions: Steve Forbes Loves Private Equity

JOEL SAGET/AFP/Getty ImagesSoak them not: Fortune has smiled upon private-equity managers. Should they give more of their winnings back? Steve Forbes says no.

FOREIGN POLICY: Lawmakers on Capitol Hill want to tax private-equity firm managers at the ordinary income tax rate of 35 percent rather than the 15 percent rate for capital gains that they pay now. Supporters of this move point out that partners at these private-equity firms pay a much lower portion of their astronomical salaries in taxes than their secretaries do. How would you explain to an ordinary, middle-class worker in Des Moines, Iowa, why this is fair?

Steve Forbes: Well, capital gains is a very different animal than income. Income is regular and you get it at every fixed periodwhether its a week, two weeks, twice a month. Capital gains, as weve seen with the recent turbulence in the market, is not a sure thing. Equities can go down as well as go up. Deals can fall apart and lose money as well as make moneyso its risk. While you can say that they are making a lot of money now, as weve seen in the recent years, things dont always go in a straight direction.

FP: Princeton economist Alan Blinder recently argued in the New York Times that having a comparatively low tax rate for private-equity managers actually induces people to make bad investments. What do you say to this?

SF: Well, when you take high risks, you are occasionally going to have bad investments. But certainly in the last 15 years of equity funds, the overall return has been very impressive, far better than hedge funds. But again, thats precisely why you have a different tax rate for capital gains than you do from regular income, because risk is involved. I never see Congress getting upset when these things start to lose a lot of money. They only seem to be around after the risk is taken and the money is made, and then they say, Well, we want to put our hands in your pockets.

FP: But at a time when growing income inequality is high up on the average Americans mind and the country is in the middle of two costly wars, shouldnt the United States be focusing on fixing the budget deficit and moving toward a more progressive tax code?

SF: The key is for the United States to create an environment where you get maximum economic growth and maximum opportunity to create jobs. The United States has done very well in the job frontin the last four years weve created more jobs than Western Europe and Japan put together. Moreover, in the last four years, the growth of the U.S. economy alone exceeds the entire size of the Chinese economyin other words, we grew China in the last four years. And if we want to slap on more taxes and slow economic growth, well have the kind of economy that Europe has had since the 1970s, where job creation is a fraction of ours and entrepreneurship is mostly outside of Europe. If you want growth, innovation, risk-takingif you want an economy to remain competitiveyou need to have a benign environment.

FP: This is something that you touch upon in your recent piece in the Wall Street Journal, where you argue that raising tax rates will harm U.S. competitiveness. But is the U.S. economy really so fragile?

SF: Its not a matter of fragility, but if you pile on taxes and make for a less benign environment for growth, guess what happens? You have less of it over time. For example, the state of California has put on a lot of regulations, high taxes, and now is surprised that a lot of businesses are moving to Nevada, Colorado, Oregon, Arizona. And you see it around the world.

One of the reasons these tax proposals are starting to stall is that suddenly the real estate industry is recognizing that they could get caught up in this thing and they are vigorously lobbying against it. Pension fund managers who have been getting very good gains from equity funds dont want those gains to stop, so they are now lobbying against it. After all, these are the stewards of tens of millions of pensioners. So people may not like [CEO Stephen] Schwarzman of Blackstone, but it would be kind of foolish to punish the rest of the economy and the assets of future retirees by trying to punish him.

FP: Speaking of Schwarzman, many people have criticized his extravagance and his cutthroat mentality for sparking this whirlwind of negative publicity. People have dubbed the bill thats before Congress the Blackstone Bill or the Birthday Party Bill in reference to his 60th birthday party. Would you say that Steve Schwarzman is a bad poster boy for the private-equity business?

SF: When you have an industry that does as well as the equity-funding industry has done in recent years, politicians will always find an excuse for why they should pick their pockets and take more of their money. If Steve Schwarzman werent around, they would have invented him.

FP: Is it hypocritical for presidential candidates like Hillary Rodham Clinton, Barack Obama, and John Edwards to be denouncing private equity on one hand, and then taking thousands of dollars in donations from the industry on the other?

SF: Hypocrisy has never been a barrier to politicians. For example, Senator Edwards denounced candidates who took money from Rupert Murdoch or executives at News Corp, conveniently overlooking the $800,000 he received in advances for a book that a subsidiary of News Corp published. And the same Senator Edwards also took a half a million dollars from an equity fund that he now says he went to work for to learn more about poverty. Go figure that one out.

FP: Do you think private equitys bad image can be fixed?

SF: Well, it is what it is. Theyve only now woken up to the fact that when you succeed in the U.S. economy, you do have to pay tribute to politicians. Microsoft learned that the hard way. Wal-Mart is learning that the hard way. [Private-equity managers] have to do a little bit more to explain the kind of work that they do. Its not as glamorous as making iPods, but it does provide a service that restructures companies and enables them to make investments they wouldnt otherwise make, become more competitive, and provide returns for pension funds. Its not the kind of thing you could easily make a movie about, but it performs a very useful service in a dynamic economy like ours.

Steve Forbes is the president and CEO of Forbes and editor in chief of Forbes magazine.

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