The Privilege Tax

The socialists in Illinois have resurrected the Privilege Tax Bill.  It is a creation of the increasingly larger and dominant socialistic wing of the Democratic Party but let us be honest.  Most if not all of them agree with it.

California Democrats are trying to figure out how to continue to tax their constituents in spite of the new tax decreases that were in the Trump tax plan.  In New York, Governor Cuomo proposed the same sort of tax.  Hedge fund manager and University of Chicago PhD Cliff Asness correctly remarked that if Cuomo’s plan goes through” they aren’t running a government they are running a gulag.”  It’s tongue and cheek but the sentiment is accurate.  I find that people in our business across the spectrum have a tremendous sense of humor.

HB 4293 would impose a 20% tax, in addition to all other taxes, on fees that are based on capital gains. Hedge funds, private equity, and venture capital would all be taxed.  A parallel bill already passed in in the Illinois Senate last year, SB 1719.

"Amends the Illinois Income Tax Act. Imposes a privilege tax on partnerships and S corporations engaged in the business of conducting investment management services. Provides that the tax shall be imposed at the rate of 20% of the fees calculated by reference to the performance of the investment portfolio funds and not from the investment itself. Defines "investment management services"."

There is no logical argument that will hold any water with the people that support this bill.  They don’t understand basic blocking and tackling economics.

I would agree, it is my privilege to be trusted by my LP’s to make decisions on investment with money they earned.  Everyone had freedom of choice.  Me to enter and build a business and them to invest.  Realize some of these fund managers put their own capital in their own funds.  But, it’s risk capital.  It’s not a free ride.   A lot of times these investments don’t work out.  Many are middling.  When they do work out, they are outsized.  They create a lot of wealth for the founders, the executive team, the employees and the investors.  They should.  Companies that are successful are solving problems for other people.  The money that goes into the companies sits for years.  There is an opportunity cost to that money while it sits inside a company creating jobs and opportunity for thousands of people. 

This is how innovation gets funded.  This is how society makes great leaps forward.  This is why our country was founded on capitalistic principles.

Chicago has a thriving trading scene.  The greatest minds in the world are located in Chicago trading markets.  Risk capital and risk transfer built the entire city and all of its charitable institutions.  Bertha Palmer went to the trading floors to raise money for those institutions.  Those bank buildings you see on LaSalle Street aren’t there because of a mayor, or government.  They are there because of the building at 141 West Jackson.  Chicago would be a grease spot on the prairie if it wasn’t for the CBOT opening up in 1848.  Read the book City of the Century to understand the history of Chicago and how not much has changed.

In 2007, we started Hyde Park Angels and lit a fire under the local tech scene.  Last year over $1B was invested in tech companies in Chicago.  Finance and tech startups are the only business bright spot in Chicago these days.

An aside, the future of the internet runs through cryptocurrency and blockchain.  Chicago has been a leader here.  Back in the 1980’s, the internet was built two and half hours south in Champaign, IL.  The entrepreneurs couldn’t get funding in Chicago.  They received it in California and companies like PayPal were built out there, not here.  The proposed change in the tax law will guarantee that crypto and blockchain get built somewhere else.

I have seen transaction taxes proposed as well.  CME Chair Terry Duffy had to go down to Springfield to testify about it.  He said CME would leave the state overnight if they passed a transaction tax.  So would the CBOE.  So will every fund manager and the startups will follow them.  Remember, CME sold its data center.  With the flip of a switch, all the trading that goes on in the Aurora data center will take place in a state that is friendly to finance and wants traders to be there.  In the startup world, much of the work can be done virtually.  Physical presence isn’t as important and with blockchain emerging as a trust network, will become less important.

What the opposing side doesn’t realize is that when it comes to fixed assets like houses, they are line items on a lot of people’s balance sheets.  That’s not where their net worth resides.  A co-op I once lived in didn’t even count real estate as a part of your net worth when you applied to live there.  Selling the house at a loss is never fun but they will do it.  They will hit a bid and not look back.  Once they make the decision to leave, there is no getting them back either.  Finance is the only thing that keeps Chicago from looking like Detroit, Baltimore and other places that are depressed.  Already, many people have repatriated their citizenship to places like Florida without selling their homes.  My friends were just in Florida with a bunch of Chicago folks who were checking it out and they are all moving.

I was at a dinner once and had a Democrat tell me that Detroit was on the upswing. I said, “Sure, in a six-block area.  Do you really want to go to the depths they hit in order to have an “upswing”?”  With this tax, that’s exactly where Chicago will go and it won’t take long to get there.

I am at the point where I know someone with any economic sensibility about them can’t say anything that would change the hearts and minds of the opposing side.  As one of my Republican friends in government said, “They are like roaches.  They are relentless.”  Hence, I say pass the taxes.  Do it.  Increase the taxes on carried interest to 100%.  Why stop at 20%?  After all, we didn’t build it.  I’d encourage them to pass a transaction tax at the same time.  Go all in.

It’s 7 degrees in Chicago today.  No one in finance stays for the weather.  I am in California.  Here, they stay for the weather. However, many Californians are leaving. People stay in both California and Chicago for the network.  In our case, we have deal flow in Chicago.  We want to be there and we want to stay there.  We have funded two companies in Chicago and one in NYC.  HPA has put money into over 40 local Chicago firms.  Passing a privilege tax and passing a transaction tax will cause the network to get together and move en masse.  I know I will leave and it will be post-haste.  I hear Texas, Florida, and Tennessee are nice this time of year.

UPDATED

From Crain’s Chicago:

Illinois needs a graduated income tax. It needs a “LaSalle Street tax” on financial trading. And it ought to think about dropping out of the expensive race to lure Amazon’s HQ2.

That was part of the news from Democratic gubernatorial hopeful Daniel Biss today in an appearance before Crain’s editorial board in which he doubled down on his core populist message, arguing that what ails the state and its economy isn’t too much spending or excessive regulation but a taxation system “written for an economy we don’t have any more.” (View the video below.)

The state senator from Evanston—who’s started to move up in the latest polls—also effectively apologized for his sponsorship of a pension reform bill that offended organized labor and eventually was ruled unconstitutional by the Illinois Supreme Court. And he renewed his attack on Democratic frontrunner J.B. Pritzker as “Madigan’s candidate,” while downplaying his own ties to Illinois House Speaker Mike Madigan.

His key solutions: amending the Constitution in the 2020 elections to allow a graduated income tax and imposing a tax on financial transactions on the Chicago Mercantile Exchange, Chicago Board of Trade, Chicago Board Options Exchange of $1 for agricultural products, $2 for financial trades. That idea matches proposals from the Chicago Teachers Union and others on the political left.

Again.  Pass it.  Pass the tax on fund managers.  Let’s get it over with and let the chips fall where they may.