* Republican gains could mean gridlock, even in lame-duck
* Losing Democrats seen as unenthusiastic about a tax deal
* Wall Street counting on extension of lower rates
By Kim Dixon
WASHINGTON (Reuters) - Republican gains in U.S.
elections next month boost the odds of Congress letting
Bush-era tax cuts die at year end, a worst case scenario for
Wall Street, and the opposite of the party's stated goals.
Prospects had seemed assured for months that the current
Democratic-controlled Congress would strike a deal to extend
the rates before the end of 2010.
But now, with Republicans looking likely to take control of
the House of Representatives and gain substantial influence in
the Senate, tax policy watchers say neither side will be in a
mood to bargain in the post-election "lame duck" session.
"I don't think Democrats are motivated to extend them and
Republicans won't have the political base during a lame-duck to
extend them all for as long as they like," said Scott Hodge,
president of the right-leaning Tax Foundation.
Polls show Republicans making substantial gains in Congress
in the Nov. 2 election -- enough to block President Barack
Obama's legislative agenda and perhaps even force his hand on
some issues -- on the back of voter angst about the economy and
near 10 percent unemployment.
But a tax decision would likely come in the final days of
the current session, and before the new Congress begins in
January. Democrats will be in the majority in Congress in that
period and political gridlock is possible.
A senior Democratic House aide said that a number of
Democratic lawmakers have no interest in extending the Bush tax
cuts for anyone. "The are Bush's tax breaks and they never
liked them in the first place," the aide said.
Wall Street economists have been cautiously watching for
months, worried that political deadlock could lead all tax
rates to expire, further choking the limp economic recovery.
"Political gridlock in Washington may not necessarily be a
good thing," Bank of America economists wrote this week.
"Inability for policymakers to compromise on the extension of
the Bush-era tax cuts could shock the economy in 1Q 2011."
Tax rates for all individual income groups, including rates
on dividends and capital gains, will rise at year-end if
Congress fails to act.
President Barack Obama and most Democrats had tried to pass
legislation extending low rates for families with income of
$250,000 or less.
But a small but vocal minority in their own party backed a
rival proposal from Republicans to extend all the tax cuts --
including those for families with income above $250,000.
HOLDING OUT
Republicans say extending lower rates for all taxpayers
will boost the economy. But most Democrats say that wealthier
Americans are unlikely to spend cash immediately and that the
country can simply not afford the cost of the all the cuts.
Congressional Budget Office Director Douglas Elmendorff has
advised that extending the tax cuts would be a short-term boost
to the economy, but the increased government borrowing to pay
for it, without any other changes in fiscal policy, would weigh
heavily.
While the newly elected Congress does not convene until
January, Republicans could gain four Senate seats right away
due to vacancies that will be filled this year. But that might
not be enough to get what many Republicans really want:
long-term extension of all the Bush-era lower tax rates.
"Why would you settle for a half a loaf?" an industry
lobbyist said of Republicans' potential strategy.
JP Morgan has estimated expiration of all the cuts could
cut about 1 percent to 1.25 percent from GDP growth over the
course of a year, as personal income falls.
If Congress allows the low tax rates to expire, it would
likely just be temporary. Republicans and many Democrats would
push to reestablish the tax cuts in some form in 2011.
Much depends on how fast Republicans can consolidate
power.
"Obviously the sooner they fix it up the better," said
Rudolph Penner, an economist at the left-leaning Urban
Institute, who said it could be a "disaster" if they all
expire.
Leading up to the election, Obama defended letting tax
rates rise for wealthier Americans -- about 3 percent of
taxpayers -- saying the country could not afford to keep
missing out on $700 billion in revenue.
But will he change his mind with Republicans breathing down
his neck?
"The big question is whether talk of 'Obama 2.0' means the
president can climb down after his strident pre-election
opposition to extending the tax cuts for upper income
taxpayers," Capital Alpha analyst Jim Lucier said.
(Additional reporting by Donna Smith and Thomas Ferraro,
editing by Jackie Frank)
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