WASHINGTON President Barack Obama and fellow Democrats will be playing defense in what is a heated issue this U.S. election season, whether to extend lower tax rates for the rich during a waning economic recovery.
Despite a risk of being perceived as coddling the rich and fueling deficits, Republicans have the upper hand in selling renewal of lower tax rates for a small slice of wealthy Americans, political analysts say.
The critical battle will likely affect the November elections, where Republican hope they can win at least one chamber in Congress.
"Democrats never have the upper hand on the tax issue, and recent spending doesn't help," said Bill Galston, a Brookings Institution analyst and former adviser to former President Bill Clinton.
Congress must act to prevent tax rates on all Americans from rising on January 1, 2011, when the so-called Bush tax cuts expire.
Democrats favor renewing the Bush cuts for individuals earning less than $200,000 and families making less than $250,000. Republicans want all lower rates extended, arguing that raising taxes will crimp spending and thus hold back the recovery.
There is a very real chance that congressional gridlock leads to expiration of all tax cuts -- which neither party wants -- or a temporary renewal of all cuts, which would be a win for Republicans.
"Democrats will dare Senate Republicans to (block) a bill that extends breaks for all but those with high incomes," Sean West, an analyst at Eurasia Group said in an investor note.
"When they oblige, Republicans will be accused of holding the lower and middle income tax breaks 'hostage' for the sake of the rich."
Broad tax cuts were enacted in 2001 and 2003 under former president George W. Bush. To ease the long-term price tag, they were set to expire December 31, 2010.
Under current law, tax rates will rise January 1 for all income groups. For the two top groups, rates rise from 33 percent and 35 percent, to 36 percent and 39.6 percent.
Letting the reduced top rates on the wealthiest lapse would impact just two to three percent of all Americans.
Still, a Pew Research Center poll last month found the public torn. Thirty percent back extending all the lower rates -- the Republican view -- while 27 percent back extending lower rates for those making under $200,000 only -- the Obama plan.
But at the same time, 31 percent favor letting all the lower rates expire, an idea backed by former Federal Reserve Chairman Alan Greenspan, who cites the need for tax revenue to tame the growing budget deficit.
These tax cuts do not come cheap. Making all the lower middle income tax rates permanent and extending other popular breaks would cost $1.3 trillion over 10 years, according to the congressional Joint Committee on Taxation. Extending the lower tax rates for the top two income brackets adds $700 billion over a decade.
SUBTLETY IS A HARD SELL
Republicans came out swinging on the issue as they headed into the August congressional recess.
"This has been tax policy for 10 years," Senate Minority Leader Mitch McConnell said recently. "We look forward to the debate about raising taxes in the middle of a recession."
Most Democrats point to the estimated $1.47 trillion budget deficit expected for the 2010 fiscal year, calling the low rates a luxury the United States can no longer afford.
"Borrowing to finance tax cuts for the top two percent would be a $700 billion fiscal mistake," U.S. Treasury Secretary Timothy Geithner said last week "It's not the prescription the economy needs now."
Republicans have opposed additional spending -- such as $34 billion for extended unemployment insurance -- but have managed to de-link the benefit of tax revenue from the deficit.
"Republicans have been brilliant about making the argument about the deficit and not carrying it over to this tax break," said Sandy Maisel, professor of government at Colby College.
It is unclear whether Democrats will push for a vote to extend the middle class cuts before the November election. At a minimum there will be congressional hearings.
House Speaker Nancy Pelosi said she backs a pre-election vote, which will enable the Democrats to hammer Republicans during the campaign for pushing a "tax cut to the wealthiest people in America."
Three Democratic Senators have come out in favor of extending all the lower rates, even if temporarily, because of the bumpy economy.
That means Democrats need to pick up a few Republicans to get 60 votes needed to beat back a filibuster -- the procedural hurdle the minority uses to prolong debate indefinitely.
(Editing by Simon Denyer and Philip Barbara)