A Treasury Department proposal included in President Clinton's budget effectively would kill the latest version of investment pools known as "exchange" funds by eliminating their tax advantage.

Also known as swap funds, "exchange" funds allow investors with a large holding in one stock to diversify into a basket of securities without having to pay capital-gains taxes.

Under current law, taxpayers are able to achieve diversification without gain recognition. This result is inconsistent with prior legislation. Tax payers should not be able to exchange, tax-free, an appreciated asset for an interest in a diversified investment portfolio.

This is one of the most popular tax-saving techniques for wealthy investors.

The Treasury Department proposal would require taxpayers to recognize gain upon the transfer of marketable stock or securities to a corporation or partnership that is essentially a passive investment vehicle. It has also been drafted broadly enough to ensure that swap funds will not re-emerge in another form. Congress has tried several times to eliminate exchange funds, only to see them resurface in other forms.

The proposal would be effective for transfers occurring on or after the date of enactment of the legislation.

This tax proposal has a good chance of winning congressional approval. Because exchange funds are available only to the wealthiest investors, their effective elimination would be politically palatable.