CAPITAL GAINS LOOPHOLE

Congressional tax writers have been considering what to do about a tax break enjoyed by a new crop of multimillionaires. They are the managers of hedge funds, lightly regulated investment vehicles that make risky bets and often reap large profits. The wealthy investors, who must open their accounts with $1 million or so, are considered able to afford any losses in these risky ventures.

Here is how these managers reap their own riches: They typically charge a fee of 2 percent of the total investment plus 20 percent of all profits. Any losses are borne by the investors. Instead of this “2 and 20” system, some hedge funds have gone up to “3 and 30.”

Their tax break comes from an interpretation of these 20 or 30 percent earnings as capital gains, now taxable at 15 percent, rather than earned income, taxable as high as 35 percent. This generous interpretation helps them amass their new fortunes and pay for their yachts, private jets and the mansions that are now crowding out the “old money” in Greenwich, Conn., home of many of the hedge funds.

Critics of the present system make the case that the 15 percent tax on capital gains is intended to provide an incentive for risk-taking investors by letting them keep 85 percent of their profits. And yet, they say, the hedge fund managers are handling other people’s money, not their own. Thus the 20 or 30 percent share they take of the investors’ profits should be considered earned income and should be taxed like everyone else’s wages and salaries.

Sen. Hillary Clinton put the issue in simple terms in a statement issued by her presidential campaign: “It offends our values as a nation when an investment manager making $50 million can pay a lower tax rate on her earned income that a teacher making $50,000 pays.”

For some of the others, it gets complicated. Sen. Clinton’s fellow New York Democrat, Charles Shumer, warns against actions that would drive capital away from New York City and opposes singling out financial services for tax revision. Neither Senate Finance Committee Chairman Max Baucus, a Montana Democrat, nor the committee’s senior Republican, Charles Grassley of Iowa, has decided whether to change the tax status of hedge fund managers, although they want to increase the funds’ taxes.

Another ticklish factor is the possibility that hedge funds are a bubble that could burst. Several have recently lost heavily or gone belly up. Still another is a continuing dispute over whether the Bush administration was justified in pushing for cutting the tax rate on capital gains down to 15 percent.

And in the background is the fact that hedge funds are heavyweight political contributors, especially just now to Democratic candidates.

Still, fairness is fairness, and it isn’t right for a multimillionaire to pay so much less than a middle-income worker for what they both are earning by their skill and energy.