Now, I normally don’t get excited about tax policy. Mostly because it is obscure. But this got me annoyed, so here goes.

Senators Baucus and Grassley have introduced a bill to shut down a "loophole" in the tax code as it relates to private equity. The basic idea is that private equity partnerships are taxed as capital gains, not income. The long-term capital gains tax is around 15%, while the US has the highest corporate tax is the industrial world after, I believe, Japan. So they want to tax private equity partnerships as corporations under the higher tax rate.

Now there are reasonable arguments for this. One is that private equity has a significant advantage versus corporations because they get to keep around 25% more of their profits. So the current tax code could be said to create "unfair" competition. That is, if the current tax code had any sense of fairness in it at all, which it doesn’t. But that’s not what is going on here. This is a story of the government trying to stop someone from getting rich by outthinking Congress, something most Americans would argue isn’t that hard.

Let me start with a story about the tax code from a friend who was a Senate Democratic tax staffer:

A constituent had asked for a small tariff on a kind of purse several years before. The purpose of this tariff was to screw the less politically-connected competition. The goal was to create more demand for their bag by raising the prices for their competition. But, several years after the tariff was introduced, fashions changed, and this company wanted to move into this market, which had the tariff that they had asked for. So they went back to ask for a repeal of the tariff.

That’s how our tax code works. Some honest businessman got screwed because some other politically connected businessman made a bad decision. And that’s what is going on here. Private Equity looked at the tax code and figured out how to structure their companies so that they made money. There’s nothing wrong with people making decisions based on taxes or prices. I am driving to Canada for a family reunion this weekend. I will have to make decisions about when to purchase gas. I might buy it in NY, PA, MD, or VA. And most of the difference in cost is due to regulation (taxes plus varying environmental standards)

Now, if our Senators made the change take effect for partnerships created in the future, sure. I might be ok with that, because there really is a competition issue here. (don’t tell the credit unions!) But that’s not how this became a political issue. It became an issue because the unthinkable is about to happen. Somebody is about to make a boatload of money by out-thinking the tax code:

Meanwhile, Democrats, and some Republicans, are taking aim at the booming private-equity buyout industry, especially the much-ballyhooed public offering of Steve Schwarzman‘s Blackstone Group. It seems these buyout guys are just too rich.

Up to now, Blackstone’s authoring statement had envisioned some kind of two-tiered tax plan, where ordinary corporate compensation would be taxed at the 35% corporate rate while high-risk investment-fund profits would be taxed at the 15% capgains rate. And now, Senators Baucus of Montana and Grassley of Iowa want Blackstone to pay the much higher corporate tax on all its income.

Better stop those guys from making that money. That just ain’t right.

If the Dems want to make an issue of people using the tax code in innovative ways, they need to start with a redesign of the tax code from scratch that introduces some notion of fairness. Get rid of all the various loopholes and tax earmarks. Get rid of all the tax breaks for their buddies and all the other corporate welfare. But don’t go grabbing the money of the guys who just ended up being smarter than Congress.