In 1977, investors put up a meager $37 million in venture capital to finance entrepreneurs and their small, newly hatched companies.

By 1983, the total had soared to $4.7 billion, an outpouring of money that has helped fuel the recovery with an indispensable boost of new jobs and economic growth.

Because so much of this money has gone to computer, software, biotech and other high-tech companies, a healthy venture capital market is seen as being crucial to the competitive strength of America's high-tech sector, now facing an intense foreign challenge.

But the venture capital industry sees its financial support from investors mortally threatened by the Treasury Department's new tax proposal, which eliminates preferential treatment of long-term capital gains.

A key to the dramatic growth in venture capital was a succession of reductions in the taxation of capital gains, in 1978 and again in 1981, which gave investors a powerful incentive to take the risk of backing start-up companies. In the early 1970s, the maximum tax rate on long-term capital gains stood at 49 percent; by 1981, the rate was down to 20 percent.

In the Treasury plan, investors' profits from buying and selling stock in start-up enterprises would be taxed the same as other income, eliminating this preferential treatment.

That would devastate venture capital, said Rep. Ed Zschau (R-Calif.), head of a House Republican task force on high-technology issues and a former Silicon Valley entrepreneur.

Zschau and other venture capital advocates argue that it was the increase in capital gains taxation in 1969 that paved the way for this country's industrial slump in the 1970s. "We have some history on what happens when you reduce the incentives for risk capital. It dries up," he said.

"Whether it's the artificial heart or the Apple computer. . . we're talking about what keeps the process alive. What pushes our technology is the competition from the bottom up," said Daniel T. Kingsley, executive director of the National Venture Capital Association.

Zschau and Kingsley said there is little comfort in the inflation protection offered by the Treasury proposal, which permits investors to reduce their gains on the sale of stock, for example, by the amount of inflation during the time they owned the stock.

A venture capitalist is betting on high-risk companies and hoping the successful ones make big payoffs -- profits far in excess of inflation rates -- and for such investors, inflation protection isn't much of a plus, they said.

Finally, the Treasury proposal would reduce the taxation on investors' dividend income -- and while that is a welcome step in and of itself, it may also tip the scales against start-up entrepreneurial firms, Zschau said. These companies hoard their cash to finance research and expansion, as opposed to large, established companies that use a large part of their profit to reward shareholders.

"The fallacy that the Treasury makes is saying that all income should be treated the same," and then giving a preference to dividend income over capital gains income, said Kip Hagopian, a venture capitalist and president of the National Venture Capital Association.

But the protests from the venture capital forces are not matched by the grown-up venture firms that have become established high-tech companies.

For them, the Treasury plan offers equal tax treatment, for the first time, with financial institutions, insurance companies and some basic industries that have done particularly well under current accelerated depreciation rules.

As the Treasury plan noted, the effect of depreciation rules and the investment tax credit has been to create huge disparities in the way various industries are taxed -- based on how much capital investment they do and how rapidly their capital equipment and inventories must be replaced.

There really isn't an income tax. The government ends up taxing what is left over after corporate tax accountants and lawyers finish applying a crazyquilt of special provisions, preferences and tax breaks.

The resulting variations in effective tax rates create a kind of industrial policy, favoring some industries and haphazardly hurting others. The great irony is that some of those penalized most are the high-tech companies that hold the greatest hope for growth and rising standards of living.

Venture capitalists like Hagopian appreciate the importance of ending this favoritism, but they are fixed on resisting the elimination of the capital gains tax preference. By the same token, the established high-tech firms also like the fairness of the Treasury plan -- but they are really excited about keeping their favorite tax break, a special credit for research and development expenditures.

The new and established high-tech companies have a common interest in tax fairness. But their reactions to the Treasury plan illustrate the continuing tendency to see tax policy as a battle for special privileges rather than a general good. And that is fatal to tax reform.