U.S. Senate tax bill fails budget challenge

WASHINGTON, June 16 (Reuters) - A Democratic bill to extend jobless benefits and some popular business tax breaks that would also raise taxes on investment fund managers failed a key test vote in the U.S. Senate on Wednesday.

Democratic leaders fell far short of the 60 votes needed to overcome a Republican challenge that the bill, which would add about $80 billion to the U.S. deficit over 10 years, violates Senate budget rules against deepening the federal deficit.

Democrats plan to offer a scaled-back version of the bill in an effort to win over some moderate Republicans and advance the legislation.

The Senate also will consider, but likely reject, a Republican alternative to extend unemployment insurance for 30 days, but exclude the controversial tax-raising provisions.

The bill would extend some popular business tax breaks and pay its estimated $126 billion 10-year cost in part by increasing taxes on investment fund managers who now enjoy low 15 percent capital gains tax rates on much of their earnings.

The bill would tax 65 percent of investment fund managers' earnings at higher normal income tax rates in the provision that would take effect in 2011.

A tougher version passed by the House of Representatives would tax 75 percent at ordinary income rates.

Under current law, the top income tax rate is set to rise to 39.6 percent in 2011 from the current 35 percent. The top long-term capital gains tax rate is also slated to rise in 2011 to 20 percent from 15 percent currently. (Reporting by Donna Smith; Editing by Vicki Allen)