7 Min Read
* McConnell vows to introduce tax-freeze bill
* Senate back from recess with short session
* Bitter debate ahead of November congressional elections (Adds options to vote or delay, capital gains tax question)
By Kim Dixon and Andy Sullivan
WASHINGTON, Sept 13 (Reuters) - Republicans in the U.S. Senate poured cold water on Monday on hopes for a compromise with President Barack Obama that would have allowed Bush-era tax cuts for the wealthiest Americans to expire.
Taxes have become a flashpoint going into a Nov. 2 election in which Republicans are seeking to wrest control of Congress from the president's fellow Democrats. Obama says the cost of keeping the tax cuts for the rich is too high as the United States emerges from recession with a massive budget deficit.
The uncertainty over tax policy is hanging over the slow economic recovery and is keeping investors guessing about what will happen to taxes on capital gains and dividends.
Prospects faded for breaking the deadlock when Republicans gave a cool reception to a signal on Sunday by John Boehner, their party's leader in the House of Representatives, that he might be willing to bend.
In a political gambit, Senate Republican Leader Mitch McConnell proposed a freeze on all tax brackets, insisting that cuts for wealthier Americans, as well as for the middle class, must be kept in place.
"I'm introducing legislation today that ensures that no one in this country will pay higher income taxes next year than they are right now," McConnell said on the Senate floor.
With control of the Senate, Democrats should be able to dictate whether there is a vote on the tax question ahead of the election but it is far from clear if they have enough party unity on the issue. McConnell may be hoping for enough defectors to bring his measure to the floor.
If Congress fails to take any action on the tax cuts enacted for all Americans under George W. Bush, Obama's Republican predecessor, then they will expire at the end of this year.
Positions are so deeply entrenched and the risks so high for both sides that lawmakers may opt to put the issue on hold until after the election.
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Obama raised the stakes last week by accusing Republicans of holding middle-class tax cuts hostage to salvage lower rates for the rich.
In Fairfax, Virginia, on Monday, the president pressed his case for keeping the Bush tax cuts only for families making $250,000 or less a year and blamed the Republican leadership for a "wrestling match" that has held up action.
"We just can't afford it," he said of the estimated $700 billion that would be needed over a decade to keep the tax cuts for higher income brackets.
Obama has portrayed his push for maintaining lower taxes for most Americans as critical to bolstering the economy, which is expected to weigh heavily on the prospects for Democrats in the November elections.
Republicans say wealthier Americans are drivers of the economy and that tax cuts for them help the whole country.
Democrats could bring up the measure in the Senate next week, hoping to force Republicans to vote against a popular middle-class tax cut ahead of the elections. Democratic aides cautioned that no firm decisions had been made.
The danger for Democrats -- even if Republicans manage to block the move -- is their opponents on the campaign trail could then cast them as tax raisers in a struggling economy.
Don Stewart, McConnell's spokesman, said Senate Republicans were united and had enough votes to block Obama's plan.
Some Democrats have distanced themselves from Obama's call to let tax cuts expire for individuals earning more than $200,000 per year and families earning more than $250,000, arguing the economic recovery is too weak to impose tax hikes.
Republicans are also sending mixed signals.
Boehner said on Sunday that, if given no other choice, he would support extending tax cuts for the middle class even if cuts for the wealthy are allowed to expire.
But Eric Cantor, the No. 2 Republican in the House, showed no sign of backing away on Monday from a full renewal of the Bush cuts and called for a vote on whether to extend them.
Several opinion polls show a majority of Americans support letting the tax cuts for the rich expire but the issue has made some Democrats nervous before the election in which many of their seats are in jeopardy.
Lawmakers are just back from a summer recess and most analysts believe that, with roughly two weeks of legislating time left before they break again, the tax issue could get punted to after the election.
Also, there is still no consensus on how to deal with levies on capital gains and dividends, now taxed at 15 percent for high earners. Republicans want to keep that rate, while Obama wants to raise both to 20 percent for individuals making more than $200,000 and families earning above $250,000.
If Congress fails to act, the rate will hit about 40 percent for high earners.
"I don't think it makes sense to raise any federal taxes during the uncertain economy we are struggling through," Independent Senator Joe Lieberman, a former Democrat, said in a statement on Monday. (Additional reporting by Thomas Ferraro, Steve Holland and Donna Smith; Writing by Matt Spetalnick; Editing by John O'Callaghan)