ICYMI – Why Tax Collectors Should Love Private Equity

Today, Real Clear Politics published the following op-ed from American Investment Council Chairman and New Mountain Capital Founder & CEO Steve Klinsky. In the piece, Klinsky discusses how the private equity industry is a major contributor of tax dollars to the federal government. Klinsky also examines how private equity builds businesses across America and has emerged as a leader on Environmental, Social, and Governance (ESG) initiatives.

Read the full op-ed below:

Why Tax Collectors Should Love Private Equity
Real Clear Politics
By Steve Klinsky, AIC Chairman and New Mountain Capital Founder & CEO
July 14, 2021

Any government leader, or writer at ProPublica, seeking more federal tax revenues should love the private equity industry. Private equity is the ultimate “tax event” machine.

Last month, ProPublica published an expose of the taxes paid by Warren Buffett and others. The key finding was that, because some executives never sell any shares, they never trigger any taxes. Their net worth keeps rising on paper, with no tax revenues paid.

“Buy and hold” is hardly illegal, but the reality is that private equity firms can be described as “buy, build, sell and pay tax.”  The basic job of a private equity firm is to continuously buy or start companies, increase their value through strategic and operating improvements, and then resell those companies or their shares — generally within a 10-year period — to return gains to investors in cash. Every time PE buys a company or sells a company, it is likely to crystalize gains for federal tax collection purposes. PE transactions make the federal cash register ring.

And these days, private equity is ringing the federal cash register a lot! The Financial Times has just reported that buyout groups have announced 6,298 deals so far in 2021 alone, worth $531 billion.  If we assume that PE prices are twice the underlying tax basis of the companies bought, then the taxable income generated by PE firms, as they acquire, could be about $250 billion in the past six months alone.

And PE then generates more taxes as it sells. There are now around 5,000 PE firms, owning (and eventually to be selling) over 30,000 companies, worth an estimated $5 trillion or more. Every one of these 30,000 company sales by PE can be another potential tax collection event for Uncle Sam and the states.

PE also generates taxable income for the government by building companies better and faster than any comparable asset class.  Returns for the PE industry on average have consistently exceeded pension returns generally, and exceeded public equity returns.  Further, the public equity measures are usually tied to the S&P index and the Dow, which regularly remove weak performers from their index and substitute in stronger ones.  If we look at just the top quartile of PE firms, the outperformance for PE is even more massive. Nor is this surprising since more and more of the best operating executives have left public companies (where they are subject to sometimes irrational 90-day earnings reporting pressures) and have joined private equity, where they can have more equity ownership and can manage companies privately for long periods of time.

Along with tax generation and business building, the PE industry is now also a leader in adding social or “ESG” value to companies. Pension funds and endowments exert tremendous influence over the PE firms they invest with, and these “LPs” (institutional limited partners) have also demanded and received extensive environmental, social, and governance reporting from the PE firms.

My own firm, for example, has published a “social dashboard” each year since 2008, even before our LPs asked for it.  As of the end of 2020, we have added or created over 49,000 jobs at our PE portfolio companies, net of any job losses. We have spent over $5.9 billion on R&D, software and capital expenditures. We have never had a PE company bankruptcy or missed an interest payment. We have generated over $50 billion of gains for all constituents.

Collectively, all the PE firms and their portfolio companies now employ over 11.7 million people, and generate over 6.5% of U.S. GDP.  Of all the businesses receiving private equity investment in 2020, 86% employed 500 or fewer workers. PE delivers trillions of dollars of much needed financial capital and management skill to Main Street companies; generally, to the local companies that would be far too small to ever go public on the public equity markets.

In short, private equity is not a form of tax avoidance. Private equity is a form of business value creation, and tax revenue creation, of the highest order.

Steve Klinsky is chairman of the American Investment Council, and founder and CEO of New Mountain Capital.