The Democrats may be outmaneuvered on the Battle of Iraq, but they are laying the groundwork on another of their strategic goals — a plan to increase tax rates on dividends and capital gains. That is the warning we have been receiving from those following the eight hours of hearings last week chaired by Congressman Rangel in the cavernous home of the Committee on Ways and Means. You read it here first. The trouble ahead involves more than a tax hike on hedge fund and private equity managers that has been an announced topic of the proceedings. Testimony and conversations on the Hill suggest that between capital gains, dividends, and ordinary income. Several persons testifying at Mr. Rangel’s hearing last week skated in this direction. It is conceivable that the plan could be advanced under cover of bringing down the top rates — a smidgen — but applying the top rates to a broader base. The drift of the hearings suggests that the effective tax rate on corporate income could also go up, primarily by ending tax exclusions for overseas income.

Investment income that is double taxed — once as corporate profits and then again as income to the individual — could be hit with a double whammy of two higher tax rates that investors wouldn’t soon forget. Taxes on future income, like capital gains, would slap investors with a tax-hike trifecta. If Mr. Rangel moves forward with such a plan, and Wall Street takes notice, it wouldn’t be long before the market started discounting the higher-taxed future that has always been the aim of a Democratic congress. New York, and not just New York, could see a situation in which investors with accumulated capital gains to protect would rush to sell before the new tax rates take a bite of their holdings.

So far, both the politicians and Wall Street have been slow to appreciate the unfolding tax drama in Washington. The Street has given its attention to what may end up as a sideshow, the commotion over carried interest through which incentives go to certain fund managers. Carried interest is currently considered a capital gain and taxed at the rate of 15%. Some conservative economists, such as Harvard’s Greg Mankiw and the Cato Institute’s William Niskanen, argue that such interests should be taxed like profits from any ongoing business. The danger is that, as Congressman Tom Reynolds warned, the issue will turn out to be a “Trojan Horse” for those who seek to tax capital gains in general at ordinary income rates.

The Street has been strangely oblivious to the possibility that the 15% rate for capital gains and dividends will go away for all investors if the Bush tax cuts expire in 2010 as they do in current law. New York’s hometown industry, whose moguls include many big political donors to the Democrats, fears it could lose the 15% tax rate as early as this year. So it is financing a frenzy of lobbying in Washington, treating the capital city to advertising that purports to show that civil liberties, minority and women entrepreneurs, and middle class pensioners will all be hurt if carried interest gains were to be taxed at the ordinary income rate of 35%.

Where is the effort to defend the 15% rate on investment? We sense a state of denial. Hill Democrats with a nervous eye on the 2008 election cycle had been chary of suggesting they will repeal the Bush tax cuts on investment income before 2010. Not so any longer. What Mr. Rangel gave a glimpse of was a narrative that will build over the next two years and establish the broad outlines of a tax “reform” — i.e., hike — no later than 2009, perhaps in partnership with, say, President Hillary Clinton or President Obama. Thursday was the opening salvo in a campaign against the investor-friendly tax cuts of 2003.

No one should be fooled by the talk of repealing the alternative minimum tax. Among the basic points advanced in the Rangel hearing were that tax cuts don’t advance economic growth, that tax cuts can leave the recipients worse off in the balance, that American can’t afford to extend the Bush tax cuts because it will need money for entitlements after 2010, and that the Bush tax cuts aren’t legitimate anyway because they give the top one million earners benefits that are paid for in part by letting 23 million middle income taxpayers fall victim to the AMT. Clearly it all spells a broad hike in taxes on capital gains and dividends. Mr. Rangel has his eye on 2009.