A weak economy and tight congressional elections are amplifying the stakes in a battle that was already contentious – whether to extend Bush tax cuts when they expire at the end of the year.
President Obama wants to keep income tax cuts in place for most Americans, but taxes to rise back to 1990s rates for households making $250,000 or more. He espoused that view even during his campaign for president in 2008.
But now he faces opposition not just from Republicans but also from some in his own party, who say that with economic recovery fragile, it's the wrong time to raise taxes on anyone. At the same time, the public has become more worried about both tax hikes and high federal deficits – a mood that puts power-wielding Democrats in a tight spot for fall elections.
The looming decision that Congress must make on tax rates comes at a sensitive time for the economy. The momentum of recovery has cooled and consumer confidence has receded in the past two months. On top of that, some economists say that fiscal policies of government are starting to exert a drag on the economy, rather than a stimulus. A key reason: State and local governments are cutting spending.
Most forecasters don't see the economy falling back into recession, but they do see a real risk that could occur. Raising taxes on the rich would add a new burden, in part because wealthy Americans make a significant contribution to overall consumer spending.
At the same time, economists say that high federal deficits and a growing national debt represent a critical threat to the nation's economic health in the future. And although spending is vital to any solution, many say a fix also requires more tax revenue.
Tax policy expert Leonard Burman summed up his view of the quandary at a Senate hearing earlier this month.
"It would be a serious mistake to make any of the tax cuts permanent now," said Mr. Burman, of Syracuse University. "However, I also think it would be a mistake to allow all of the tax cuts to expire as scheduled in 2011. The economy is in a very precarious state and a major tax increase would slow the economic recovery."
The American public shows similar concerns. In a new Rasmussen Reports poll, the percentage of voting adults saying taxes are a "very important" priority has jumped recently to 68 percent, putting it near the top of voters' agenda. And 70 percent of the public views reducing the federal deficit as a top priority, according to a recent Pew Research Center poll. It's a concern that's almost equally shared by Republicans, Democrats, and independents.
Election-year pressures may cause Congress to delay action until the so-called "lame duck" session, the period after the November election but before newly elected lawmakers replacing the outgoing ones in January. That could be Democrats' best window to take a politically risky vote. But the vote could be difficult whenever it's taken.
The House Republican leader, John Boehner of Ohio, has been tagging Obama's policy as a "job-killing tax hike on families and small businesses." In a statement this week, citing a study by Congress's Joint Committee on Taxation, he said that half of US small business income would face higher taxes if the top two tax brackets revert to pre-Bush levels.
Supporters of Obama's plan say that tax cuts for the affluent are a relatively ineffective for of economic stimulus, since those households are less likely to immediately spend the extra dollars they get to keep.
And, although the joint committee found that half of small-business income would be see higher tax rates, that doesn't mean the tax change would affect half of all small businesses. In fact, the report said only about 3 percent of all households that report business income would be affected.
Whatever the merits of both views, the question of tax cuts for the rich is unlikely to be an issue that tips the economy into a new recession. According to an analysis by Goldman Sachs, the income tax and capital-gains tax money at stake is only about $34 billion for 2011.
The debate isn't just about politics, however. How the tax policy debate gets resolved will have an effect on economic growth, and on the ability of the government to get its finances on track.
The Bush tax cuts for top income brackets, if extended for a decade, would total more than half a trillion dollars in lost federal revenue. The Bush cuts for lower income brackets total $1.6 trillion over that same decade, according to Goldman Sachs.