A tough case to make

No one who works in the confident world of private equity would describe himself as ordinary.

Executives at private equity firms never profess to own just ordinary degrees of talent, and the income they earn at work is anything but ordinary. As the rest of the world is now figuring out, there's nothing ordinary about the taxes private equity people pay, either.

In a nutshell, you're ordinary, and they are not. Guess who gets a break on taxes?

Private equity partners earn a good living on a flat annual charge, usually 1 percent or so of money managed in their funds, but they make the really big money in an arrangement known as carried interest. It carves out 20 percent of investment profits as a fee for themselves. That fee might look like ordinary income, akin to a big paycheck bonus, but private equity partnerships pay taxes on the money as if it was a capital gain. That means they pay a tax rate of 15 percent, less than half the 35 percent corporate rate on ordinary income.

The arcane subject of partnership taxes found its way onto the front burner in the past week thanks to the populist perfect storm known as the Blackstone Group LP, one of the nation's premier private equity firms.

It started with the outlandishly lavish 60th birthday party Stephen Schwarzman , the firm's take-no-prisoners chief executive, threw for himself. Then the Blackstone initial public stock offering hit the market last week and raised billions for partnership insiders, particularly Schwarzman. In a business that thrives on discretion, these were not welcome developments.

In the process of going public, Blackstone drew attention to the partnership capital gains issue. Right out of the box, Blackstone was lobbying to kill or delay any effort to revoke its tax advantage. By the end of last week, Democrats filed a bill that would not only change all of private equity's capital gains tax treatment on carried interest, but also the treatment of venture capital partnerships and, to a lesser degree, hedge funds.

Those Democrats, including Representative Barney Frank of Massachusetts, didn't need help connecting the dots in a story about really rich financial people paying low taxes. But a similar public debate was already playing out in England, where private equity firms were taking their lumps.

Private equity and venture capital partnerships argue they are entitled to capital gains treatment on their carried interest because they are taking risks to create value. If businesses they own go bust, they don't get paid a dime that is entitled to capital gains treatment.

Here's the problem with that idea: It may have been fair years ago, when the numbers were so much smaller, but that's not the case today. Private partnerships that take 20 percent of the profit they earn for their investors are getting paid well for their efforts and shouldn't complain so much about their taxes.

I have more sympathy for venture capitalists, who often take bigger risks and have to wait longer to get their money out of companies that eventually prove successful.

I have less sympathy for private equity firms, who earn a large portion of their huge profits thanks to very low interest rates, buying expensive equity with cheap debt. It's one thing to earn buckets of money in that arbitrage, but it's another to insist that you're entitled to favorable tax treatment on that income.

Sophisticated people with lots of money find ways around tax problems, and no doubt private equity partnerships will manage with their army of lawyers and Washington lobbyists. It's not like they're ordinary taxpayers.