Democrats: We hate the rich, we love the rich

WASHINGTON (Fortune) -- More and more Wall Streeters - especially those new-money hedge fund and private equity managers with net worths stretching toward and beyond the billion-dollar mark - are throwing their considerable moneyed weight behind Democratic candidates. So far, presidential contenders Hillary Clinton and Barack Obama have managed to charm these masters of Manhattan with their policy smarts and scent of potential victory, even while decrying the country's "highest concentration of wealth...since 1929," as Clinton puts it.

Candidates can get away with tailoring their messages for different audiences on the campaign trail. But on Capitol Hill, choices have to be made, and votes cast. That's why the legislative brawl over taxing hedge and private equity funds is one to watch. Don't let technical jargon like "tax treatment of carried interest" scare you: The question of whether fund managers' compensation should be taxed at a 15-percent capital gains rate or 35-percent income tax rate has left the glass offices of clever tax attorneys and entered the swirl of presidential politics, where it provides a vivid stand-in for America's conflicted emotions about brazenly wealthy people.

In another era, this might be a slam dunk for populist-minded Democrats: A new class of billionaires doesn't pay the same tax rates as ordinary Americans, leaving tens of millions of dollars more in their pockets to spend on private helicopters and ivy-clad boarding schools and Nantucket summer homes. What better example of Republicans favoring the rich?

But wait: These new Greenwich/Manhattan billionaires happen to be donors, friends, and constituents of Democrats--not Republicans. What's a presidential candidate to do?

For John Edwards, the left-leaning Southerner whose ties to this world pretty much start and end at the firm that once employed him, Fortress Investments, the answer was easy: Raise their taxes. Obama, a far more popular figure on Wall Street, quickly followed suit, leaving both men in good stead with liberal-leaning, populist-minded Democratic primary voters.

The question was stickier for Clinton, who has a much longer history of cultivating Wall Street, first as New York's junior senator, later as a presidential candidate. Clinton spent several weeks "evaluating" a Senate bill to double hedge fund taxes, before deciding to end this "glaring inequity." She added: "It offends our values as a nation when an investment manager making $50 million can pay a lower tax rate on her earned income than a teacher making $50,000 pays on her income."

So the top Democratic presidential contenders are now in sync. But on Capitol Hill, the Democratic Party saga continues. And on a hot summer morning, just before Congress broke for its August recess, the party's conflicted feelings towards its wealthy new friends played out neatly inside the same Senate office building, just three floors apart.

On floor 2, Democrat Max Baucus opened his Senate Finance Committee hearing with a melodramatic rendering from the New Testament. "The Apostle Paul wrote of this world: 'Now we see through a glass, darkly.' We could say [as] much about the world of hedge funds and private equity. The world of hedge funds and private equity is opaque." Especially for a senator from Helena, Montana. Together with the self-described "farmer from Butler County" - Iowa Republican Charles Grassley - Baucus is behind the push to double taxes on hedge funds.

On Floor 5, though, Connecticut Democrat Chris Dodd, '08 presidential candidate and chairman of the Senate Banking Committee, was playing a starkly different tune, praising hedge funds for performing a "very, very important and valuable role in the capital markets." His state, of course, is home to scores of hedge funds and some of his biggest campaign backers are employed by Steven Cohen's SAC Capital Partners and others.

Dodd was careful to say he hasn't taken a position "one way or another" on the tax hike proposal. But he could barely conceal his annoyance at the mischief underway in that "other committee" three floors below. Dodd said he worried that a tax increase could have "potential adverse effects on capital formation, on job creation, and on institutional investors like pension funds and college endowments."

Dodd was joined on the dais by New York Senator Charles Schumer, who routinely trolls Wall Street donors for party candidates in his role as chairman of the Democratic Senatorial Campaign Committee. Keeping the Democrats in control of the Senate in '08 also means keeping big donors happy. Schumer, also a member of Baucus' finance committee, piped in with his own concerns about singling out hedge funds for the higher tax rate. "I want to see New York stay a financial center," he said. "The increase in financial service jobs in London exceeds the increase in financial service jobs in New York."

In the end, the powerful Dodd-Schumer duo could put the kibosh on the tax increase proposal, giving the party the best of both worlds, at least for now: Democratic presidential candidates who continue to issue populist appeals to tax the rich, and a Democratic Congress that leaves its new friends alone.