The US Senate finance committee met in private last Thursday evening to try to deal with a vestige of the Bush era that looks set to become a critical battleground in the November congressional elections, and threatens to split the Democrats.

Max Baucus, the Montana Democrat who chairs the committee, called the meeting to consider the fate of about $3,000bn in tax cuts that were enacted early in the George W. Bush administration, and will expire at the end of the year.

“This was more exploratory, figuring out what is the best policy for our country,” Mr Baucus said later.

The Obama administration, together with many congressional Democrats, wants to extend the tax cuts for those earning less than $250,000 per year, while allowing them to expire for wealthier people accounting for between 2 and 3 per cent of the population.

Republicans are pushing for Congress to extend the measures for all income categories.

“Clearly it’s a big decision,” says Alan Viard, a former Bush administration and Federal Reserve Bank of Dallas economist now at the American Enterprise Institute, a Washington think-tank. “We’re talking about a large amount of revenue here, and a big impact on marginal rates.”

If the Obama administration has its way, the highest tax rate for high-income earners would rise from 35 per cent to 39.6 per cent, while capital gains and dividend taxes would also increase for richer Americans from 15 per cent to at least 20 per cent.

Some members of the president’s own party are nervous. Last week, Kent Conrad, the North Dakota Democrat who chairs the Senate budget committee, said Congress might want to keep tax rates where they are for another 18 to 24 months, until the economy had improved.

“The general rule of thumb would be you’d not want to do tax changes, tax increases . . . until the recovery is on more solid ground,” Mr Conrad said, joining other conservative Democrats in the Senate, including Evan Bayh of Indiana and Ben Nelson of Nebraska, in opposing the expiry of tax relief for upper income brackets.

As the possibility of defections within Democratic ranks increased last week, both Tim Geithner, Treasury secretary, and Nancy Pelosi, speaker of the House of Representatives, reiterated their determination to end the tax cuts for the wealthy.

On Sunday, Mr Geithner told ABC’s This Week that letting tax cuts expire for the wealthy would “not have a negative impact on growth” – adding the move was the “responsible thing to do” in terms of America’s fiscal outlook.

One ace up their sleeve in confronting both sceptical Democrats and Republicans is America’s growing concern over its high budget deficit and rising debt burden. The administration estimated in February that allowing the tax cuts for the wealthy to expire would save $678bn during the next decade, a figure which will undoubtedly be used to undermine Republican criticism that the administration is fiscally reckless.

The administration might also try to insist on the claim that tax relief focused on middle-class Americans is more effective economic stimulus, since poorer people are more likely to spend the money faster, while the wealthy will hold on to the extra cash for savings and investment.

Republicans, especially, are unconvinced. “To those who are pushing the higher marginal rates, I say the burden is on you to show that you are not harming our primary job creators, small business,” said Chuck Grassley, the top Republican on the Senate finance committee, this month.

Mr Baucus – along with Harry Reid, Senate majority leader, and Ms Pelosi – will have to strike a difficult compromise in the coming months. As well as the renewal of the tax cuts, other sensitive issues, including the reinstatement of a 45 per cent estate tax that lapsed last year, could also be addressed in a single bill that could emerge from the Senate finance committee in September, after the summer recess.

One Democratic congressional aide said it would be very difficult for any lawmaker to oppose tax increases for the wealthy if it meant voting against tax relief for the middle class.

However, the urgency to come up with the solution is palpable, especially since Republicans are not hesitating to talk about what might happen if Congress fails to act altogether.

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