Thursday, August 02, 2007

China, India and private equity

The debate about the tax treatment of private equity rumbles on. The New York Times today lambasts the New York Democrat Charles Schumer who appears to be defending the tax breaks enjoyed by private equity. Schumer has been claiming that it would be "unwise and unfair" to support a tax increase on financial firms unless it is also applied to other partnerships that get the same tax break. Fine - but he should then lead the charge to achieve this too. A similar debate about the unfair tax treatment of private equity has been raging on the other side of the Atlantic.

But the issue is broader than this. It goes to the heart of a long-term trend in the global economy. The relationship between labour and capital has been fraught with political tensions even before Karl Marx was born. Now, however, the rise of new economic powers, notably China and India, is ratcheting up the pressure. Their entry into world markets has massively increased the world supply of workers, while adding relatively little new capital. This is slashing the ratio of capital to labor, which inevitably means greater returns to capital relative to labour. So the rich are getting richer fast, while poorer people struggle just to tread water. This rising inequality is one of the great political challenges of our age.

What can governments do? The New York Times, in another editorial, provides a big part of the answer.

In this age of hyper-inequality, shouldn’t we be making the tax code more progressive, not less?

One way to do this would be to raise taxes on capital, and use this to fund lower taxes on labour. The private equity tax breaks have to go.

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