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Connecticut starts border war over NY hedge funds

By Joan Gralla

NEW YORK (Reuters) - Connecticut Governor Jodi Rell on Wednesday restarted her state's on-again, off-again border wars with New York by inviting hedge funds to relocate to escape rising income taxes.

Cash-starved New York is poised to collect an extra $50 million a year by assessing income taxes on hedge fund managers who work in the state but live elsewhere.

This would be accomplished by taxing their carried interest -- profits gleaned by managing assets -- at ordinary income tax rates. Titans in the hedge fund and private equity world who live in New York already pay income taxes on these profits.

But until the state legislature included this proposal in a $1 billion revenue bill to help balance the budget, out-of-state commuters who worked for firms in New York escaped this levy.

New York state's highest income tax rate of 8.97 percent for people who earn more than $500,000 a year tops the equivalent income tax rate of 6.5 percent in Connecticut.

And any hedge fund or private equity chiefs who decided to keep commuting to their offices in New York would be paying both states' income taxes -- on the same earnings.

"As lawmakers in Albany consider a proposal to vastly increase the tax liability of hedge fund professionals who work in New York - many of whom have already wisely decided to live in Connecticut - I would like to convey a very simple, yet heartfelt, message: Connecticut welcomes you!" Connecticut's Republican governor wrote the New York Hedge Fund Roundtable, a trade group.

Over the years, Connecticut has succeeded in attracting hedge funds and private equity firms to Stamford, which otherwise might have been expected to settle on Wall Street.

Mayor Michael Bloomberg also saw New York's tax hike as a win for Connecticut. "I think it's the best thing that ever happened to Connecticut; I can't think why every hedge fund wouldn't pick up tomorrow and move," he told reporters.

New York City, home to many of the mega-rich in the United States, relies heavily on taxing their income and job-creating spending in shops, theaters, florists and the like.

Just 5,000 people, whose incomes topped $4 million, paid nearly 39 percent of all the city's income taxes in 2007.

New York has also clashed with New Jersey in the last few decades, as it lured major financial firms that moved across the Hudson River to Jersey City, for example.

New Jersey's top income tax rate matches New York's rate.

But New York's wealthiest individuals also will be paying higher income taxes due to two other provisions in the bill the state legislature is expected to enact as soon as Thursday.

Knocking out property tax rebates for the ultra-rich will add a few tenths of a percentage point to New York's top income rate. And their charitable deductions will be halved to 25 percent of their state income.

Hedge funds and private equity executives face another risk: though it has failed so far, Congress still might raise federal tax rates on their carried interest.

(Reporting by Joan Gralla; Editing by Kenneth Barry)

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