President Barack Obama's plan to extend tax cuts for all Americans ran into trouble on Tuesday when his fellow Democrats questioned it and investors dumped U.S. Treasury bonds on fear that low taxes will dig a deeper hole in the budget deficit.
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While analysts believe Congress will probably approve the deal, Obama faced a rift with many in his party who think he was too quick to compromise with Republicans on taxes.
Democrats had sought tax reductions only for the lower and middle class and their support for the deal remained unclear before they hand over control of the House of Representatives to Republicans next month.
Obama said the deal would give a much-needed boost to the economy, which is still struggling to recover from the deepest recession in 70 years.
"This package will help strengthen the recovery. That I'm confident about," he told a news conference.
Economists reckon the compromise tax plan should eliminate uncertainty on tax policy, help reduce unemployment and raise economic growth in 2011.
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The deal calls for a 13-month extension of unemployment benefits, which could placate Democrats. But Obama also conceded to Republican demands on the estate tax by proposing a 35% tax with a $5 million individual exemption level.
The Obama plan would cost $501 billion in lost tax revenues, according to the non-partisan Congressional Budget Office, at a time when voters are increasingly concerned about budget deficits that have approached 10% of economic output in recent years. A Senate Republican aide estimated the tax cuts will cost $700 billion.
House Speaker Nancy Pelosi emerged from an evening meeting with fellow Democrats telling reporters that there was "unease" in her party with aspects of the tax-cut plan.
That was evident from Representative Sander Levin, who chairs the tax-writing House Ways and Means Committee. "We expressed very serious concerns" about estate tax breaks in the plan that were won by Republicans.
BOND MARKET FEARS
Initial relief waned fast in financial markets, triggering a steep sell-off in U.S. Treasuries on spreading concern that the tax deal worsens the U.S. deficit and will stoke inflation.
Demand was weak at the three-year note auction, and the 10-year Treasury note suffered its worst sell-off since June 2009. Its yield jumped to 3.13%, up from 2.93% on Monday, which will ricochet through the economy by pushing up mortgage rates.
U.S. and European stocks had earlier risen on the deal.
Moody's Investors Service said U.S. finances could suffer in the long run.
"This reduces revenue on top of extending jobless benefits, which is bad for deficits. In the short run this is good news, but two to three years down the road foreign buyers of U.S. Treasuries may start to balk," said David Carter, chief investment officer at Lenox Advisors in New York.
Taxes would go up for almost all Americans if no extension is approved. Analysts predicted the tax-cut measure would ultimately become law as enough Republicans would back the deal to offset the Democrats who oppose it.
Obama leveled some of his toughest criticism to date at the left wing of the Democratic Party, saying his critics were taking a "sanctimonious" position.
His voice rose and he sounded exasperated when he told a news conference that if he had refused to compromise with the Republicans then, "People will have the satisfaction of having a purist position and no victories for the American people."
House Speaker Nancy Pelosi said Democrats would "continue discussions" on the deal in coming days. Representative Steny Hoyer, the No. 2 House Democrat, said he had not yet decided whether to back it. No date has been set for a vote.
The White House said the deal would achieve Democrats' priority by preventing a tax increase for working families that would average $3,000. It would also help those struggling in the wake of the worst recession since the 1930s by extending unemployment benefits and other tax cuts focused on those with more modest incomes, it said.
Economists say the plan could raise economic growth by 0.5% to 1.0% next year and lower unemployment.
"In all likelihood, the recovery would have made it through next year without backtracking into recession, but this deal improves those odds significantly," said Mark Zandi, chief economist at Moody's Analytics.
The deal would create 2.2 million jobs, according to the liberal Center For American Progress, giving a much-needed boost at a time when Congress has been unable to pass spending-based fiscal stimulus measures.
But many Democrats argued that Obama had given Republicans their top priority -- extending the tax breaks for the richest 2% of U.S. households -- without getting enough in return.
Some said Obama should have fought harder to set the tone for future negotiations with Republicans.
"By giving in this early I think we've just emboldened them," said Representative Raul Grijalva, a leader of the Progressive Caucus who said he would vote against the deal.
A Republican aide warned that his party would block the inclusion of Build America bonds, a taxable bond program popular with states, cities, and other municipal issuers.
Tax breaks for ethanol, clean technology, and employers who hire unemployed workers were also in the mix.