Buyout King Kravis' Use of Loopholes May Have Cost Taxpayers as Much as $96 Million in 2006
WASHINGTON, April 15 /PRNewswire-USNewswire/ -- School bus drivers, janitors, and nurses were among the workers who came out on tax day to send a stern message to Congress to close tax loopholes that encourage buyout kings like KKR's Henry Kravis and Carlyle's David Rubenstein to utilize risky debt-laden business models to earn hundreds of millions a year while allowing them to pay a lower tax rate on their huge investment incomes than nurses have to pay on a $50,000 salary. SEIU estimates -- based on public figures -- that Henry Kravis' creative use of tax loopholes may have cost taxpayers somewhere between $58.6 million to as much as $96 million in 2006.
In New York City, Labor unions, the Working Families Party, elected officials and tax-burdened small business owners and workers held a news conference on the steps of City Hall challenging a NYC specific city tax loophole which allows wealthy investment firms to avoid paying their fair share while low- and middle-income New Yorkers pick up the tab. Workers in other states contacted their elected officials, state pension boards and staged street theater to challenge federal loopholes.
Today, Brave New Films, the producer of the documentary "Wal-Mart: The High Cost of Low Price" and dozens of online viral videos, released "The War On Greed, starring Larry the Loophole," an instructional cartoon on the inner workings of the private equity industry. "Private equity is an intricate and complex money-making tactic, but it comes down to a very simple bottom line: greedy financiers make a killing, while taxpayers get screwed," said Robert Greenwald, director of Brave New Films. "We thought a cartoon could explain it better than any pundit." "The War On Greed, starring Larry the Loophole" is viewable at http://www.warongreed.org/.
"Millions of Americans are worried about losing their homes to foreclosure; there is growing fear of a recession; and states are facing record deficits," said Stephen Lerner, director of the Service Employees International Union's private equity project, "Yet buyout execs will file their income taxes this year and again, many will pay a lower tax rate than nurses and doormen. There is going to be increasing pressure on Congress to take a hard and serious look at how the buyout industry uses the tax code to transfer billions into their pockets and away from the needs of the country."
While losses tied to subprime mortgages have been the primary catalyst for the credit crunch, banks have also been stuck with hundreds of billions of dollars of leveraged loans for private equity buyouts that they can't sell, contributing to their losses, constraining their capital, and helping to freeze up the market for collateralized loan obligations. According to a recent Wall Street Journal report, corporate loans like those used to finance buyouts, together with other types of debt issued in recent years, collectively "threaten to deepen the financial system's wounds and create a growing pileup of shaky assets on the books of banks." It appears that some buyout firms are now trying to profit on both sides of the equation by buying up the loans on their own (and other) deals from the banks at a steep discount.
These same loans constitute the basis both for the incredible profits that private equity buyouts generate, and for one of the major tax dodges the buyout industry uses. By having the companies they are going to buy borrow the lion's share of the amount necessary to finance their own purchase, buyout firms' return on investment can increase exponentially. (See chart for greater explanation.)
Companies then deduct the interest on that debt off their taxes, frequently reducing their income tax obligation to almost nothing. In the Washington Post, Max Holland, writing about RJR Nabisco, characterized the tactic as a "gigantic transfer of wealth from the U.S. Treasury to a small group of investors skilled in manipulating the tax code."
"The numbers involved run into the billions," said Stephen Lerner, "According to estimates, Biomet, which is just one of KKR's deals, could cost nearly $800 million in lost tax revenue thanks to the debt and carried interest loopholes."
On top of the billions that their target companies siphon away from state and federal treasuries, buyout executives pay a tax rate of 15 percent on much of the income they earn from buyouts while most taxpayers have to pay significantly more. Henry Kravis earned a reported $450 million from deals in 2006. Assuming that $450 million was classified as capital gains rather than income, Kravis was able to pay just 15 percent tax rate, rather than the 35 percent he would have owed on ordinary income, at a cost to taxpayers of as much as $96 million in lost revenue.
The buyout industry and its manipulation of tax loopholes to avoid paying its fair share of taxes is receiving greater scrutiny as Americans struggle with a growing sense of anxiety over the state of the economy and the expanding income gap between the very richest Americans and those in the middle class. The industry has also invested heavily to defend the tax code it has so skillfully mastered. In 2007, KKR alone paid more than $2 million for lobbying on Capitol Hill, including lobbying to fight legislation in Congress that could have closed tax loopholes.
CHART
Investment A
1. Buy a $100 company with $100 cash
2. Sell the company for $120 cash after one year
$120 - $100 = $20 = 20% Return on Investment (ROI)
Investment B
1. Buy a $100 company with $50 cash and $50 debt @ 10% interest
2. Make one $5 interest payment
3. Sell company for $120 cash after one year
4. Repay $50 loan
$120 - $5 - $50 - $50 = $15 = 30% ROI
Investment C
1. Buy a $100 company with $25 cash and $75 debt @ 10% interest
2. Make one $7.50 interest payment
3. Sell company for $120 cash after one year
4. Repay $75 loan
$120 - $7.50 - $75 - $25 = $12.50 = 50% ROI
Service Employees International Union
