After decades of flying below the radar screen, a tax policy allowing private equity fund managers to claim their fee-based income as capital gains rather than ordinary income has suddenly become the subject of media scrutiny, congressional hearings and legislation. In June, the Blackstone Group, a large private equity firm, went public with an initial public offering, which resulted in billion-dollar profits for the principals. This triggered House Ways & Means Committee and Senate Finance Committee chairs Rep. Charles Rangel (D-NY) and Sen. Max Baucus (D-MT) to question the tax breaks that helped enable the billion-dollar profits. They announced their intention to examine tax policy regarding so-called "carried interest," a type of performance fee that is a major source of compensation for fund managers. Rep. Sander Levin (D-MI) has introduced a bill to eliminate the carried interest tax loophole altogether. In response, high-powered lobbyists have gathered to fight back. A classic confrontation between industry and taxpayer interests may be looming. The policy question concerns part of the fee that fund managers usually collect for their services. They typically negotiate a percentage of any profits on their fund's investments, called "carried interest" because, oftentimes, funds do not produce profits for several years. Because the income comes, when it does, following the sale of the fund's security assets, the argument is made that this income is like dividends or capital gains and so should be taxed at a maximum rate of 15 percent. However, some tax experts have argued that carried interest is no different from ordinary income, which is taxed at rates of up to 35 percent. The risk element in fund managers' compensation for services is quite different from investors' risk. The latter may lose every penny they have invested in the funds; they may also reap capital gains if fund assets are sold at a profit. Fund managers may not be personally invested in the funds they manage at all — in this case, they have no "downside" risk of financial loss; they may simply fail to be due compensation if the fund does not perform well enough. It is a form of contingency fee. Advocates of current policy, such as Lisa McGreevy, executive vice president of the Managed Funds Association, say that ''the whole issue is fundamental to entrepreneurship in the United States and the ability to use sweat equity to build long-term investments.'' Victor Fleischer, a University of Illinois tax professor, believes that perhaps private equity funds, hedge funds and others benefiting from the tax treatment have total assets under management of up to $1 trillion. It is unclear whether taxes on fund managers relate at all to investor activity. Advocates of closing the carried interest tax loophole question the equity of current policy, which, Fleischer estimates, reduces fund managers' taxes by $4-6 billion a year. Rep. Peter Welch (D-VT) says that ''there is absolutely no reason some of the richest partnerships in the world should be able to rip off American taxpayers because of a tax loophole.'' On the other side, the lobbyists are trying to convince Congress that such legislation would hurt the average citizen. Rep. Eric Cantor (R-VA) was quoted in the July 10 Washington Post as saying, "This is a tax increase not only on those working on Wall Street, but also on all blue-jean-wearing Americans because of its effect on their retirement funds." A key moment in the debate came on June 12, when former Treasury Secretary Robert Rubin, speaking to a tax reform conference run by Brookings' Hamilton Project said, It seems to me what is happening is people are performing a service, managing people's money in a private equity form and fees for that service would ordinarily be thought of as ordinary income. A week and a half later, Levin introduced his bill to end the tax treatment of these fees as capital gains. A dozen other House members have now co-sponsored the bill, including Rangel and House Financial Services Committee Chair Barney Frank (D-MA). Rangel subsequently announced that he would hold a hearing on the legislation in July. Baucus has scheduled the first of two hearings by the Senate Finance Committee, to be held July 11. The prospects for the Levin legislation in the House seem favorable, given the heft of those who have endorsed it. However, the Cantor-led forces include some of the most powerful lobbyists in town. In the Senate, Baucus and Finance Committee ranking member Charles Grassley (R-IA) have not taken a position on the issue. But in his most direct statement on it to date, Grassley, who has strongly supported tax breaks for business in the past, implied that the carried interest tax preference is failing to maintain the integrity of the 15% capital-gains rate… What I'm doing is an effort to ward off the demagogues on Capitol Hill that can say this is just a way for the rich to get richer, and the middle class to be stung... I would ask my Republican colleagues to look at it from that standpoint, that we want to make sure we aren't feeding the demagoguery of class warfare that the other party is always getting blue ribbons for doing. Whatever Congress decides, it is possible that President Bush will declare that ending this tax loophole is a tax increase and veto it on those grounds.