This Article offers a new analysis of the debate over the taxation of private equity and hedge fund managers. We provide an analytical model that allows us to compare the relative risk-reward benefit enjoyed by these fund managers and other managers. We look to "relative benefits" in order to determine the extent to which the current state of the world favors the services of a fund manager over these other workers. Our conclusion is that private equity and hedge fund managers do outperform other workers on a risk-adjusted, after-tax basis. We assume that over time compensation of private equity and hedge fund managers should approach equilibrium on a risk-adjusted basis with other comparable compensation opportunities. In the meantime, however, our model suggests that differences in tax account for a substantial portion of the disjuncture that exists at the moment. It also quantifies the significant excess returns to private fund managers that must be taken into account by those who support their current tax treatment by analogy to entrepreneurs and corporate executives. This analysis is important for two reasons. It provides a perspective on the current issue that has so far been ignored by answering the question of how taxation may affect behavior in the market for allocating human capital. It also provides quantitative precision to the current debate that relies significantly on loosely drawn analogies between fund managers on the one hand, and entrepreneurs and corporate executives on the other. This paper provides the mathematics that these comparisons imply.
Thomas J. Brennan and Karl S. Okamoto,
Measuring the Tax Subsidy in Private Equity and Hedge Fund Compensation,
60 Hastings L.J. 27
Available at: https://repository.uchastings.edu/hastings_law_journal/vol60/iss1/2