The current issue of the Harvard Law Review includes this note:  Taxing Private Equity Carried Interest Using an Incentive Stock Option Analogy, 121 Harv. L. Rev. 846 (2008).  Here is part of the Introduction:

Rarely does an idea that germinates in a law review article catch the attention of Congress. Even more rarely does such an idea inspire policy statements by presidential candidates. Recently, however, an idea that originated in Professor Victor Fleischer’s forthcoming article, Two and Twenty: Taxing Partnership Profits in Private Equity Funds, has done both. The issue to which it relates is the taxation of the so-called “carried interest” that private equity professionals earn from their funds’ investments. …

Led by Professor Fleischer, tax scholars, former policymakers,8 legislators,9 and even some business executives have argued that carried interest is, in substance, compensation for labor and should be taxed as such. They have accordingly called for tax law reforms that would, at least in some instances, raise the rate of tax that private equity partners pay on their carried interest. Opponents — principally private equity partners and those who represent them — argue that these reforms would create inequity, encourage investors to expatriate their capital, or otherwise harm the economy. The issue has even become a talking point for 2008 presidential hopefuls. No politically viable resolution of the issue has yet emerged, however. This Note seeks to offer one — one that is both moderate and rooted in existing tax code paradigms.

Part I describes the tax statutes and regulatory pronouncements applicable to carried interest. Through comparisons with other forms of incentive compensation — specifically, stock and stock options — it explains why the tax treatment of carried interest is peculiar and highly favorable to taxpayers, and it concludes that the form of incentive compensation that is most similar to carried interest from both an economic and a tax perspective is an incentive stock option (ISO). Part II examines ISOs in greater detail and suggests that some of the features of ISO taxation that differ from pure capital gains treatment might also be useful to bridge the gap between the sides of the carried interest debate. Part III then explores the various scholarly and legislative positions in that debate and proposes an intermediate approach to taxing carried interest. This approach is less taxpayer-friendly than the current regime, yet less aggressive and more in tune with existing and accepted forms of compensation — and therefore perhaps more politically palatable — than many proposals that have been advanced.