Taxing of derivatives in Congress spotlight

WASHINGTON (Reuters) - Tax-driven profits from complex securities, like those that helped cause the economy to crash in 2008, could be squeezed if Congress can summon the will to tackle loopholes examined at a hearing on Tuesday.

Tax-writers in Congress, laying the groundwork for what they hope will be a vast tax code overhaul, explored how investors use sophisticated instruments like credit default swaps and prepaid forwards to shift income, sometimes explicitly to avoid taxes.

"The potential for mischief is one of the reasons we are holding this hearing," said Democrat Max Baucus, the chairman of the Senate Finance Committee.

Baucus and Representative Dave Camp, his Republican counterpart in the House of Representatives, held an unusual joint hearing of the two tax writing committees to weigh the issue.

Many Democrats and Republicans want an overhaul of the convoluted U.S. tax code, including a lower corporate rate, but they disagree on the means to get there.

President Barack Obama has also called for changes, although most expect an overhaul will have to wait until after presidential and congressional elections of 2012.

Still, Camp, Republican chairman of the House Ways and Means Committee, called the joint hearings "highly unusual," reflecting "deep interest" in a tax revamp.

While derivatives can be used to hedge operational business risk -- for example, a farmer hedging against bad weather -- some investors use them to avoid the tax man, some experts said.

The notional value of over-the-counter derivatives -- securities that derive their value from other securities -- is now more than $700 trillion, or three times the value of all financial assets globally.

Bruce Thompson, a Treasury Department official during the last tax code rewrite in 1986 under Republican President Ronald Reagan, said Wall Street is vulnerable and should take note.

"The lesson of the 1986 act is when you have tax reform, nothing is safe," said Thompson, now a lobbyist at Van Scoyoc Associates. "Every provision is in jeopardy because the goal is to reduce rates as low as possible to broaden the base."

(Reporting by Kim Dixon; Editing by Steve Orlofsky)