This response written to Warren Buffett’s editorial
First, Warren Buffet’s point about carried interest is arguably correct. Basically, it is a bonus to money managers that is tied to the long-term capital gains of the investors whose money they are managing. Just because it comes out of the long-term capital gains of investors does not imply that it is a long-term capital gain for money manager. The argument is that this 20% cut of the capital gains is not inflation protected over the several years it takes to earn it, so the lower tax rate is proper. Capital gains tax rates are often a catchall for intrinsically long-term investments that are not inflation protected even if they do not involve the investment of capital per se.
Second, venture capital — what fuels our technology sector — is extraordinarily sensitive to the supply of liquid capital rich people have on hand. Rich people are the Limited Partners (LPs) behind venture capital firms. Note that this is required by government regulation, if you are not wealthy it is illegal for you to invest in tech startups. The supply of venture capital is very volatile, varying by an order of magnitude on a year-to-year basis. In lean years many tech startups go bust because the LPs do not have enough liquidity to fund the venture capital firms. Why the volatility? It is because the pool of venture capital is extremely sensitive to the free cash of rich people. When you abscond with the money of the wealthy, it creates a magnified reduction in the supply of capital available for venture capital.
People argue that it is only 10% here or 10% there but it does not show up that way at all in the venture capital pool, it is massively magnified. Venture capital supply follows the expected real return in the market very closely and accounts for things like inflation and tax losses; a 10% increase in taxes can put venture capital out of the money in many cases. And since rich people are the only people allowed to invest for the most part, they are not a fungible part of the ecosystem. With apologies, a poor person never funded my company. Anyone that claims to support both technology ventures and increasing the tax rates on those that fund them is a damned liar. If they had their way, Google, Facebook, Twitter, and myriad other companies that were built with the free cash flow of rich people would not exist. There is no two ways about it; venture capital has a very strict expected rate of return calculus that is grounded in the kind of mathematics that one finds in reality.
See more commentary about how venture capital works here: viewtopic.php?f=55&t=47912
Statistics: Posted by tortoise — Sun Aug 07, 2011 10:27 pm