The Senate Finance Committee continued its examination of whether to raise taxes on the earnings of managers of private equity firms and hedge funds by looking at the impact of carried interest taxation on pension funds.

The hearing coincided with testimony before the House Ways and Means Committee on carried interest (see House Holds Tax Fairness Hearing). Managers of private equity firms and hedge funds are generally taxed at the 15 percent capital gains rate on carried interest income, but critics argue that they should be taxed at the ordinary income tax rate of up to 35 percent.

The Senate Finance Committee held hearings over the summer on the subject of carried interest (see Private Equity Fights Tax Hike). At one of those hearings, a witness argued that pensioners would have to pay for the increased tax liability for private equity managers. The latest Senate Finance Committee hearing set out to examine whether a tax hike on the managers of private equity firms and hedge funds would be passed along to investors such as pension plans.

Ranking Republican member Chuck Grassley, R-Iowa, expressed concerns about the dangers to pension plans that might have too much invested in these markets. "I fear the day that a pension plan goes under because a hedge fund or sectors of the private equity industry go under," he said in his opening statement.

Russell Read, chief investment officer of the California Public Employees Retirement System, pointed out that only 7.1 percent of CalPERS' assets were invested in private equity and other alternative investments. He noted that private equity had historically outperformed public equity investments, but acknowledged that the best general partners at private equity firms charge the highest fees.

Alan J. Auerbach, director of the Burch Center for Tax Policy and Public Finance at the University of California, Berkeley, acknowledged that some of the burden of a tax increase might well be borne by pension investors.

"While the increase in tax liability may be imposed on fund managers, the ultimate burden of this tax increase may be borne at least partially by others in the economy, notably by the investors in the affected funds, including pension funds and, ultimately, by these funds' beneficiaries," he said in his testimony.

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