Taxing Private Equity's Carried Interest

There's one thing that I really don't understand in this argument over how the carried interest of private equity bosses should be taxed. If anyone can actually explain it to me please do. So Gordon Brown is going to change the current situation:

The days of buyout chiefs paying 10pc capital gains tax on their carried interest instead of the 40pc they would if it were treated as income look numbered if the Prime Minister's unambiguous rhetoric is any guide. "Whenever there is a loophole that shouldn't exist, we take action. On the issue of private equity, I can assure you that we will do so," he warned.

Now as I revealed in these very pages (woo! Journalistic scoop!) a few days ago I've been involved in a number of start ups: none that have yet troubled the taxman very much but still. One of the things that is entirely normal in this field is the idea of "sweat equity". Yes, the founders might put their own money in for a stake. But it's likely that at least a part of their stake in the fledging business will be purchased with their efforts to manage and grow it. Should the business succeed then any gains are taxed at the 10pc long term capital gains rate, not 40% income tax rates.

This is something we're actually pretty happy to have happen: the thought being that the creation of new jobs and corporation tax etc are worth not getting that higher rate of tax.

Now the carried interest portion of private equity seems to me to be equivalent to that sweat equity: you can argue that it is indeed income, not capital gains, certainly. But what I can't see is any way of distinguishing between the two, the carried interest and the sweat equity. For the carried interest is indeed the payment for their management oversight of the company, as is th sweat equity.

Which, as far as I can see, means that placing such equity gains in the income tax docket for the private equity guys means doing the same for the entrepreneurs.

So, is that something we really want to do? In order to satisfy the blood lust to get a few hundred (thousand?) rich people we quadruple the tax rate on hundreds of thousands of entrepreneurs?*

* Yes, I know I can be accused of talking my own book here but don't forget, before this affects me I've actually got to have a business succeed.