The debate over the taxation of investment partnerships is heating up, and New York’s senators, Hillary Clinton and Charles Schumer, both Democrats, are on opposite sides.

Senator Schumer wants to keep capital gains taxes low to protect the economy. On July 11, in the Senate Finance Committee hearings, he declared, “The United States and New York City must remain the leading country and city in the world for financial services and capital formation, and we shouldn’t do anything to jeopardize that position and make it easier for capital and ideas to flow to London or anywhere else.”

On the other hand, Senator Clinton wants to raise taxes. In a press release on July 13, she stated, “As President I will reform our tax code to ensure that the carried interest earned by some multi-millionaire Wall Street managers is recognized for what it is: ordinary income that should be taxed at ordinary income tax rates.”

At issue is the longstanding concept of “carried interest,” generally a 20% net profit share received upon sale of an investment by some hedge and private equity fund partners — the people who provide the insights and direct the investments of the funds. The other 80% is distributed among many ordinary investors — public and corporate pension funds, charitable foundations, endowments, individuals, and other equity funds.

Currently, carried interest resulting from long-term capital gains in a partnership is taxed at a capital gains rate of 15% paid by any similarly situated investor.

Rep. Sander Levin, a Democrat, of Michigan has introduced a bill that would tax carried interest as ordinary income, at a top rate of 35%, just like the 2% management fee received by partners. Mr. Levin’s argument, supported by Mrs. Clinton, is that managers are in the business of investing, and that their profits are like ordinary income, such as lawyers’ fees.

Mr. Levin’s bill should not be confused with one sponsored by the chairman of the Senate Finance Committee, Max Baucus of Montana. That bill, aimed at Blackstone specifically, would tax private equity and hedge fund partnerships that go public at a corporate rate of 35%, in addition to partners’ individual taxes.

The taxation of carried interest is so complex that the Senate Finance Committee, following its initial hearings on July 11, has scheduled a second round on Tuesday, July 31.

The treatment of a 20% share of net profits resulting from gains on investments as capital gains, along with the fee income of 2% as ordinary income, has been in place for more than three decades. These rules were adopted by the Department of Labor in the mid-1970s to let pension funds invest in capital ventures.

Carried interest on investments is treated as a capital gain because, like stocks, the underlying investments are risky. Investors in the stock market could see their assets skyrocket — or disappear — just like partners in a private equity funds.

Capital gains have generally been taxed at lower rates than earned income because of risk and uncertainty; because inflation reduces the real gains, especially over long time periods; and because investors supply the financial capital essential for investments that spur innovation, improve productivity, and expand capacity.

Many politicians follow Mrs. Clinton and Mr. Levin and say that carried interest bears greater resemblance to wage and salary income than to capital gains, so should be taxed at ordinary rates.

However, the same characteristics that are true of stock market investments also hold for private equity partnerships. Managing partners generally contribute personally between 1% and 4% of a partnership’s investment in a struggling business to be turned around, or in a start-up venture in a new technology. If the investment is unsuccessful, they receive no carried interest and lose their investment.

And many investments produce no carried interest at all. According to a report earlier this month by the Joint Committee on Taxation, 60% of funds out of a sample of 1,016 funds between 1991 and 2004 generated no carried interest. When the sample was limited to older funds between 1991 and 1997 that were more likely to produce returns, 30% produced no carried interest.

Even when they receive payment of carried interest, partners can’t breathe easy. “Clawback” provisions can require partners to give back to the business some of the early profits if later profit targets are not met.

Raising taxes on hedge funds and private equity partnerships does have a nice populist ring to it, perhaps enough to help propel Mrs. Clinton into the White House.

But proposals to tax carried interest and certain types of publicly traded partnerships inconsistently target one sector of the economy. Mr. Schumer observed that it would be unfair to tax financial partnerships differently from oil and gas and real estate — and, although he didn’t say this, perhaps all investors’ stocks and bonds.

In addition to overturning decades of tax law, raising taxes on financial partnerships would have negative unintended consequences. According to the National Venture Capital Association Yearbook, more than 60% of investors are not multimillionaires but pension funds, foundations, and endowments. Mrs. Clinton’s desired tax changes would mean less efficient capital markets, and therefore smaller pensions for millions of retired Americans and fewer foundation grants for charity and research.

Partnerships are conducive to innovation and entrepreneurship because they enable those with capital and management experience to team with innovators and entrepreneurs. Raising taxes would curtail entrepreneurs’ ability to plan for the long term.

With capital mobile in a global economy, it’s especially important to ensure that America’s environment is hospitable to investment, so that financial professionals are taxed here rather than in London or Tokyo.

As the late Walter Wriston, the former chief executive officer of Citicorp, said, “Money goes where it is welcome, and stays where it is well-treated.” Why does Mrs. Clinton want to drive it away?

Ms. Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute.