Obama fund plan more sizzle than steak

Steven Kaplan, a professor of finance specializing in private equity at the University of Chicago, said some private equity firms may in response try and raise the carry from the typical 20 percent to perhaps 25 percent.

"The second thing is smart lawyers will try to manoeuvre around this," Kaplan said. "There is a case that this is capital gains not ordinary income."

The Private Equity Council, an industry group, said it believed that profits generated by increasing the value of capital assets should continue to be treated as capital gains.

"We recognize that our country is facing enormous economic challenges," Douglas Lowenstein, PEC president, said in an emailed statement. "With more than $500 billion in new capital to invest, private equity partnerships can and will be part of the solution."

But even if still classed as capital gains tax, managers might have to pay more on carry anyway. The capital gains tax could revert back to 20 percent on January 1, 2011, unless lawmakers extend cuts that brought the rate down.

In addition, the proposal may not be approved by Congress.

"Hedge funds and private equity funds gave a lot of money to the Democratic party in the last election cycle," said Kaplan. "Why did they do that? Because they were hoping this wouldn't happen. There's an incentive from the part of the Democrats to threaten this but not pass it."

Some experts said it was included to capture the public's outrage that million-dollar fund managers squandered average Americans' nest eggs but pay lower taxes.

"Punishment is in the air," Hurley said, noting that many wealthy investors in hedge funds have not been able to access their money as redemptions have been suspended amid a flood of red ink at the funds.