Under the category of “We Told You So,” yesterday’s CongressDaily includes an analysis by Martin Vaughn that makes a point similar to the theme of our last Wire – that the debate over how to tax hedge funds is just the beginning of the debate over how to define and tax all sorts of income from ownership. Here’s how Martin sees it:

Forget Blackstone. Many smart people on both sides of the argument over whether to raise taxes on private equity and hedge fund managers’ profits see this as a proxy debate for whether the tax code should continue to substantially favor capital over wage income. It might play into decisions over whether to let the capital gains rate reset to 20 percent, as scheduled in 2010, or even whether to push that rate higher.

All of the political attention to the tax breaks enjoyed by Wall Street managers is borne, first of all, of a growing awareness of wealth and income disparity in the United States. As pointed out in a New York Times article Sunday entitled “The Richest of the Rich, Proud of a New Gilded Age,” Citigroup founder Sanford Weill and Blackstone Group Chairman Stephen Schwarzman are part of a new class of plutocrats that inhabit a realm far beyond the dearest aspirations of most Americans.

They offer a neat test case for the question: Should the tax code be further leveraged to redistribute the benefits of recent economic growth? The consensus answer among Democrats — even those that harbor doubts about the specific tax proposals on carried interest — seems to be yes.

Smart people? Us? You’re too kind, Martin. Some in Congress frame tax increases under the guise of taxing the rich, but the policies themselves, as often as not, reach deep into the middle class, individuals and businesses alike.

More on Treasury’s Review of Corporate Tax Treatment

As we mentioned, Secretary Paulson will hold a half-day conference examining our corporate tax code and its impact on American competitiveness next week. This past Monday, the Secretary held an informal roundtable discussion with a dozen or so Think Tanks and Association representatives, including your intrepid S Corporation team, in preparation for the conference.

The forum provided an excellent opportunity for us to highlight the fact that the vast majority of businesses in this country are subject to the individual income tax, not the corporate tax. Based on his response, it appears the Secretary and his staff are well aware of the importance of S corporations and other flow-through businesses to economic growth and will keep their interests in mind as they develop their proposals.

The conference itself will explore not just our rules governing the taxation of U.S. corporations but the rules of other countries as well. Simply put, while the U.S. corporate tax code has remained relatively stable for the past couple of decades, the rest of our trading partners have been on a tax cutting binge. Just by staying put, the U.S. today finds itself falling further and further behind. Here’s how Monday’s Financial Times frames the issue:

Americans have long derided Europe’s over-reliance on the state, its comparatively high taxes and its meddling in free markets as the cause for the continent’s structurally high levels of unemployment and sub-par economic performance. France’s 35-hour work week alone gave free-market talking heads enough material to last a generation. But relatively little has been written about the race among many western European nations to attract private investment by cutting corporate tax rates.

For all the chest-thumping about America’s free-market system, a quick scan of corporate tax rates around the world would suggest that America’s success is due to ingenuity and hard work rather than the prescience of its policymakers. While corporate tax rates in the US have remained at 35 per cent, the average corporate tax rate for members of the Organisation for Economic Co-operation and Development has declined from 37.6 per cent in 1996 to 28.3 per cent in 2006, according to KPMG.

America’s corporate tax rates are currently among the highest in the developed world, just as Germany, France, Spain and the UK are all rushing to cut taxes. The markets appear to be figuring this out – the MSCI European stock index is up more than 111 per cent in dollar terms over the past five years, while the S&P is up a respectable 54 per cent. In the context of these higher tax rates and a regulatory regime ushered in by Sarbanes-Oxley, it is no small wonder that London is giving New York a run for its money as the world’s financial capital.

It appears Secretary Paulson is eager to shoulder the burden of bringing the US back into the forefront of aggressive tax policy. As his opinion piece in yesterday’s Wall Street Journal states:

Tax systems have one fundamental purpose — to raise revenue — and the best systems minimize the drag on the economy. Therefore, we should ask: For a given level of revenue, what business tax regime best promotes U.S. economic growth and creates jobs? At a time when markets change rapidly, requiring businesses to be ever more flexible and swift, they are burdened with a business tax code complicated by parochial political interests. Government should not pick economic winners or losers; the marketplace has proven itself more than able for that task.

Business tax policy levers, such as the corporate tax rate, depreciation rates and investor taxes, as well as the taxes levied on small businesses through the individual income tax, should strive towards a similar purpose: to encourage economic growth by reducing the tax burden on additional investments. Yet, the current tax code distorts capital flows, hurting productivity, job creation and our global competitiveness.

We’ll be attending the Treasury conference, and look forward to the opportunity to discuss further the various ways in which Congress can improve the tax treatment of all businesses, large and small, to help U.S. companies stay competitive with the rest of the world. We’ll let you know how it goes.