Senate Democrats, in order to raise revenues “for a variety of must-do tax break extensions,” are reportedly looking, once again, at ending a senseless tax break for hedge fund managers. Both the Obama administration and the House of Representatives have embraced the change, but it has yet to make its way through the Senate, in part due to the intense lobbying of the hedge funds’ lobbyists.

Today, Sen. Chuck Grassley (R-IA), the ranking member of the Senate Finance Committee, dared Senate Democrats to follow through and actually adopt the change, essentially asserting that they don’t have the stomach:

Senate Finance ranking member Chuck Grassley said he didn’t think Democrats would let things get that far. “The House first voted to change the taxation of carried interest almost two-and-a-half years ago, and has passed legislation three times,” Grassley said. “Senate Democrats must have concerns, since the Senate hasn’t adopted the change in that timeframe. So the policy appears to be controversial with Senate Democrats.”

Senate Democrats should do their best to prove Grassley wrong, as this tax break is nothing more than a gift to the super-rich.

At stake is a provision of the tax code pertaining to “carried interest.” Hedge fund managers are typically paid in a couple of ways: a set fee and then a percentage of the fund’s profits. Currently, the second part — the carried interest — is subject to the capital gains tax rate of 15 percent, which is far below the top income tax rate of 35 percent.

We have a lower tax rate on capital gains because people earn capital gains from investing their own money. To encourage some risk taking, and thus more investing, we’ve decided that profits from such investments are subject to a lower tax rate. But hedge fund managers are not investing their own money. They’re managing other people’s money. Yet, for tax purposes, we treat their income as if it was their own money at risk.

Of course, making the change means overcoming a heavy dose of spending and lobbying. As Politico noted today, “the nation’s 10 richest hedge fund managers have dumped nearly $1 million into campaign accounts over the past several years — with much of it going to senators who’ve given them a friendly reception on Capitol Hill.” This is a drop in the bucket for this industry, as the top 25 hedge fund managers last year made a combined $25.3 billion (yes, billion with a b). The smallest payout amongst those was $350 million.

Last week, Forbes reported that many big corporations, including General Electric and Exxon Mobil, will pay no income taxes to the U.S. Treasury for 2009. (Exxon disputes this report, but refused to tell Forbes how much it will owe, and Forbes did not retract the statement.) At the same time, oil companies like Exxon are fighting to preserve billions of dollars in senseless corporate subsidies that they receive from the federal government, which the Obama administration has proposed abolishing.

These subsidies are part of a much wider problem with tax expenditures, or government spending that is administered through the tax code. Over the decades, a number of expenditures have cropped up in the tax code that senselessly subsidize corporations, huge farms, and the vacation homes for the wealthy. And anytime anyone tries to remove them, the interest involved throws a hissy fit and goes all out to protect the subsidy. Just look at the reaction of big corporations that, thanks to the recently passed health care reform bill, no longer get to both receive subsidies and write the subsidies off on their taxes.

Today, I spoke with Rep. Lloyd Doggett (D-TX), a leading proponent of cracking down on tax havens and cleaning up the tax code. He called wasteful tax expenditures “barnacles on the code” and criticized tax dodging multinationals for paying less in taxes than a local pharmacist:

I’m trying to provide some balance, by having a thorough analysis, an objective report coming out of the Joint Tax Committee and the Government Accountability Office, so that we have data to review the claims of those lobbyists. Not all of these provisions are bad, but many of are like barnacles on the code, and just as hard to scrape off as they are on the bottom of a ship…Whether it’s Exxon Mobil or many of the Wall Street institutions we were asked to bail out, I think [tax havens are] a real problem. I think we’ve had a proliferation of offshore tax havens, of corporate tax dodging. I always find it impossible to explain why a pharmacist in Bastrop, Texas, or a small retail store in San Marcos is having to pay higher rates on the income that their hard-working small business owners are earning than some multinational that can duck and dodge taxes in Bermuda or the Cayman Islands.

Watch it:

Last year, spending on tax expenditures totaled more than $1 trillion. This year, they amount to 25 percent of all government spending. But cutting them, even when they go to subsidize companies in well established industries like oil, is derided by lobbyists as raising “new” taxes. And the same goes for cracking down on tax havens: an effort to simply have corporations pay what they rightfully owe, under the statutory tax rate, is condemned as an end to American competitiveness.

Today, the House Financial Services Committee is holding a hearing to examine what is holding back banks from reducing mortgage principal (the outstanding mortgage amount) for homeowners who are underwater (owe more on their mortgage than their house is worth). Last month, after months of inaction, the Obama administration finally released the outline of a plan to encourage banks to voluntarily reduce principals.

Representatives of the banks themselves are appearing before the committee to explain their views on the new program. While the Wall Street Journal gave its article on their testimonies an inflammatory headline about rebellion, most of them are, for the moment, saying that principal reductions are indeed appropriate for a limited number of borrowers, and that they plan to follow through with Treasury’s design:

Bank of America: We are waiting for Treasury to finalize the details on this program and are very supportive of targeted principal reduction performed in a way that addresses the significant moral and financial hazards but also recognizes the reality regarding the diminished future prospects for home appreciation.

Citigroup: We expect these changes will result in more principal reductions going forward. We believe principal reductions are one of many options that must be used responsibly. We will continue to be thoughtful in how we implement these programs in scale.

Wells Fargo: In 2010, we have used and expect to continue to use principal forgiveness…In addition, absent any unexpected legal, regulatory or accounting issues that could arise from the Treasury’s detailed description of its new principal forgiveness enhancements, we also plan to implement the enhancements for first- and second-lien modifications as rapidly as possible.

But then, there is JP Morgan Chase:

We do think that large scale, broad–based principal reduction programs raise serious policy concerns, for both first and second lien mortgage loans, and particularly for current borrowers with an ability to repay their obligations. In Chase’s view, such programs could be potentially very harmful to consumers, investors and future mortgage market conditions – and should not be undertaken without first attempting other solutions, including more targeted modification efforts.

Of course, there have already been plenty of modification efforts, like the Home Affordable Modification Program (HAMP). They’ve just falling flat thanks to poor design and bank intransigence. According to the latest data, just 170,000 permanent modifications have occurred under HAMP. So are the other banks in JP Morgan’s corner, but just afraid to be seen as standing against homeowners again, or is JP Morgan the outlier here?

My main concern with Treasury’s principal reduction program is that, like HAMP, it relies too much on banks voluntarily making cuts, in return for financial incentives. As John Taylor, the head of the National Community Reinvestment Coalition, said, “I’m not optimistic that the incentives will be enough to entice servicers and investors to reduce loan principals. Will they help seven million people who are at risk of foreclosure? I will be pleasantly shocked if investors step up for half a million borrowers.”

If this is going to work, Treasury needs to step up and issue its guidance, and the program’s progress will have to be very closely monitored. Then we’ll see if the big banks are merely paying lip service to helping homeowners or if they have a genuine interest in preventing any more of a housing calamity.