New York's government seems intent on making its problems even worse by driving business activity out of the state. Governor Paterson and the State Legislature want to impose a $50 million tax on hedge fund managers who work in New York, but live in another state. First, Governor Paterson wanted to slap a $1 billion tax on people who consume sugary drinks. Then, Paterson and the Legislature raised the tobacco tax rates by almost half a billion dollars to punish smokers. Recently, they proposed almost $600 million in taxes on people who buy shoes. Taxing hedge fund managers' incentives makes no sense because Wall Street is one of the few remaining generators of wealth and revenue for the State of New York.
According to the New York Times, Paterson and the State Legislature agree on a proposal to treat most of hedge fund managers' income compensation as ordinary income. For compensation, fund managers typically receive a flat fee equal to two percent of the assets they manage plus a performance incentive equal to as much as 20 percent of the profits they generate. The performance incentive is treated as capital gains and taxed at a rate of 15 percent. But if Paterson and the Legislature have their way, they would treat the incentive as ordinary income, making it subject to income tax rates as high as 35 percent. Congress has rejected this proposal three times already.
By treating investment income as ordinary income, hedge fund managers who live out of state could end up paying taxes twice on the same amount of income because people are generally taxed on income by the states where they work and on investment income where they live; New York would treat the investment income as ordinary and, therefore, subject to its tax rates. This double taxation will give hedge fund managers, many of whom live in Greenwich, CT, Hoboken, NJ, and other communities around New York City incentive to avoid doing business in New York altogether so as to avoid the tax. Some state pension funds that do business with hedge fund managers in an effort to claim carried interest could also avoid the state for fear of incurring the income tax. At a time when New York is experiencing a population decline, it should not be giving people, especially the ones who contribute much to the state's economy by generating billions of dollars worth of taxes from business activity, incentive to stop doing business in the state altogether and go somewhere else.