Tax break battle seen leaning Obama's way

Signs advertise in English and Spanish at a tax preparation business in Falls Church, Virginia April 8, 2010.

WASHINGTON (Reuters) - With another April 15 U.S. deadline for filing tax returns looming, 2010 is likely to be the last year of lower taxes for the wealthiest Americans.

President Barack Obama and most fellow Democrats want to let Bush-era tax cuts expire for those earning more than $200,000 and households making more than $250,000.

The plan is to extend the existing tax cuts for those making lesser amounts, a careful political calculation in an election year where the entire House of Representatives and a third of the U.S. Senate face the judgment of voters.

Letting the tax cuts expire for those in the upper income groups would only impact about 2 percent of the U.S. population but generate about half a trillion dollars over ten years, according to the Obama's budget plan issued February 1.

Analysts generally expect the need for revenue, and Democrats' control over the White House and both houses of Congress, to win out.

"I don't think that simply rolling over all the tax rates is the most likely scenario," said James Lucier, who advises investors at Capital Alpha Partners.

The timing of congressional action on taxes is unclear after an intense battle over healthcare legislation and a series of other showdowns looming, including an overhaul of financial regulation.

"It is a cloud and it will probably be a dark cloud until Thanksgiving," said Greg Valliere, who advises investors at the Potomac Research Group. "For the markets, this uncertainty is going to grow as an issue as the year goes on."

Democrats favor extension of the tax cuts, enacted in 2001 and 2003, for middle and lower income individuals only. Republicans say raising taxes on the wealthy will hurt the stock market and choke growth.

Under Obama's 2011 proposal, the top two income rates would revert to 39.6 and 36 percent, the level it was in the 1990s, up from 35 and 33 percent currently.

Obama also wants to increase the dividend and capital gains tax rates from 15 percent to 20 percent, although the likely outcome for those rates is less clear.

BACKERS WORRY

Some backers of Obama's plan worry lawmakers could extend the cuts for all income groups.

Congress has less than six months before the mid-term elections, and a full plate trying to pass financial reform, select a new Supreme Court justice and pass legislation to bring down the unemployment rate.

"One could see after an exhaustive health care debate, there could be some tendency to delay major tax policy decisions -- and that would be a mistake," said Chuck Marr, director of federal tax policy at the liberal-leaning Center on Budget and Policy Priorities.

"It would make it much more likely that Congress would ultimately act to extend the tax cuts indefinitely," said Marr, a move that would add to the budget deficit.

The group wants the tax cuts for the wealthy to expire, citing a Congressional Budget Office report that said the wealthy are less likely to spend extra cash from tax breaks, compared to those in lower income brackets.

Much depends on the Senate, where Republicans have 41 votes, enough to sustain a debate-extending filibuster.

THE AMERICAN DREAM

Representative Sander Levin, the Democrat who controls the Ways and Means Committee in the U.S. House of Representatives, said recently that most House Democrats back Obama's tax proposal, but he worries about convincing the more conservative Senate.

Grover Norquist, a fervent low-tax advocate with Americans for Tax Reform, said it will be tough for Republicans to vote against a bill that extends some of the tax cuts.

"The interesting question is, if you're a Republican do you vote for it because it extends part of the tax cuts, or do you vote against it because you'd like all of them extended?"

Even though most people would be unaffected if the upper-income tax breaks expire, "most people believe in the American dream," and that could worry Democrats eyeing the elections, said Mark Bloomfield, president of the American Council for Capital Formation that favors keeping all the tax breaks.

(Reporting by Kim Dixon; Editing by Tim Dobbyn)