POLITICS
05/26/2010 05:07 pm ET Updated May 25, 2011

Democrats Retreat From Class Warfare

On one side: teachers, doctors and their patients, the jobless, disaster victims, the troops.

On the other: private equity firms, hedge funds, venture capitalists, real estate partnerships and bond holders.

It would be hard to fashion from scratch a more politically potent standoff, yet the Republican Party is barely being forced to fight -- as Democratic lawmakers balk at deficit spending and hesitate to close a tax loophole on a wealthy class of investors with close social and political ties to powerful Democrats.

At issue are two bills to preserve several soon-to-expire provisions. One of them, the American Jobs and Closing Loopholes Act, colloquially known as the "tax extenders" bill, contains several tax breaks for corporations and families, along with $47 billion to preserve enhanced unemployment benefits for the rest of the year and subsidized COBRA health insurance, $24 billion to help states with Medicaid costs in 2011 and $64.6 billion to preserve elevated Medicare reimbursement rates for doctors for the next five years.

The second cobbles together money for the war as well as aid for teachers and Haiti and Gulf state disaster relief. Though it's moving through Congress as a separate vehicle from the extenders package, it's all part of the same fight. And Democrats can expect little help from the GOP. After years of passing emergency supplemental war bills with no attempt that they be paid for -- and, in fact, while cutting taxes at the same time -- Republicans have decided that troop spending bills are now items that can be opposed without one's patriotism being called into question.

The Congressional Budget Office estimates that the extenders bill will lard the federal budget deficit with $123 billion, a horrifying sum to Democrats already under attack for spending borrowed money. But the deficit isn't what has some Dems antsy -- rather, they're concerned about a revenue-raiser in the bill that would close a tax loophole through which rich investment fund managers would otherwise funnel $18 billion to themselves over the next ten years.

The bill, pitting the jobless against the cream of Wall Street, should not present a difficult choice for Democrats. But its passage is so far from assured that Max Baucus, a Democrat from Montana who is routinely at odds with the party base, chastised his caucus during a Tuesday lunch meeting. "This is why we came here," an unusually fired-up Baucus urged.

The House was supposed to vote on the extenders bill on Tuesday but leadership, apparently uncertain of its support, pushed the vote until Wednesday afternoon -- and as the afternoon dragged on, Dem leaders continued to say they were "still working on it" until finally putting it off till Thursday.

The Senate can't act on the bill until the House sends it over. There's been something of a Catch-22 at play, with rank-and-file House Democrats unwilling to lend support without a guarantee from Senate Majority Leader Harry Reid (D-Nev.) that he can round up a 60-vote supermajority to pass the bill. House Democrats are thinking, "Why bite the bullet if it's not going anywhere? Why take the hard vote?" said Rep. Danny Davis (D-Ill.), who supports the bill. Rep. Chris Van Hollen (D-Md.), said Tuesday evening that House leadership wanted more assurance from Reid.

Reid, asked Wednesday if he could get 60 votes for the extenders package, said: "First of all, we have to see what the House sends us." He later added that he was in talks with House leadership and "we're going to see what the House does with the bill. Whatever they do, we'll do our best to take care of over here."

In the meantime, the Senate is already at work on the other bill, known as the "war supplemental," to fund the conflicts in Iraq and Afghanistan. With stimulus money running out, states are facing gaping education budget gaps that could lead 300,000 educators to lose their jobs over the summer -- such layoffs are not the kind of policy that is helpful in an unemployment crisis.

Iowa Democrat Sen. Tom Harkin, with the backing of the White House, proposed adding $23 billion to the war supplemental to stave off the firings. The teachers may end up casualties of Washington's deficit myopia. "I have no Republicans who want to vote for it, they'd just as soon see 300,000 teachers laid off next year, I guess," Harkin told NPR. In response, Republican Roger Wicker of Mississippi told the station that deficit concerns trump all else and that students can make do in bigger classes. "There are measures available to state governors like increasing class size, like foregoing salary increases," said Wicker.

Harkin, said his spokeswoman, has decided to pull his teachers amendment but hopes the House includes the money in its version.

The extenders bill is the target of an aggressive lobbying campaign by investment fund managers, who favor Democrats over Republicans with generous campaign contributions and have close social ties with the party of FDR that stretch back to the Clinton era, when being a Wall Street Democrat became a post-political way to do both well and good.

The notion that a Democrat can still defend Wall Street and remain true to the party's principles may no longer have currency with the base but Democrats in Congress still cling stubbornly to it, even as it blunts the sharpest political weapon they have to carve up the GOP. And Republicans are willing to make it easy. Asked two weeks ago about where Republicans stand on closing the loophole, the Senate's number two Republican, Jon Kyl of Arizona, debated whether, from a money manager's perspective, it would be considered a loophole at all. "One could describe it as a loophole. Those people who work under that regime right now, I don't think they'd describe it as a loophole," he said.

Whatever you call it, it allows investment managers to pay a radically reduced tax bill by deeming their income to be "carried interest." By cleverly structuring their compensations packages, they are allowed to pay the long-term capital gains tax rate of 15 percent on what is, in practice, income for a service provided -- namely managing money. Regular investors would not be caught up in the loophole closure -- merely those whose job it is to run investment funds.

It's not that Democrats want to tax hedge fund managers and venture capitalists. Indeed, the last time the fund managers came under attack in 2007, it was Democrats, led by Sen. Chuck Schumer (D-N.Y.), who quietly killed the effort to close the loophole. But they're running out of options: The revenue streams that were easiest to divert into federal coffers -- known as "payfors" on the Hill -- have all been sopped up by the health care reform bill and subsequent spending packages. By demanding that the health care bill be fully paid for, President Obama exhausted the congressional store of payfors. And, gripe congressional aides, his administration wasn't judicious in how it used the variety of payfors that were available. "We'd say, 'You can use this or this payfor.' And they'd use both," said one Senate aide.

That leaves the private equity guys, the ones who do leveraged buyouts.

Baucus and House Ways and Means Chairman Sandy Levin (D-Mich.) agreed in principle two weeks ago that the spending would be offset by closing the loophole. They set about working out the details, but have encountered stiff resistance from within the party. In the Senate, John Kerry (D-Mass.), Maria Cantwell (D-Wash.), Bob Menendez (D-N.J.), Mark Warner (D-Va.), Jeanne Shaheen (D-N.H.), Bob Casey Jr. (D-Pa.) and Patty Murray (D-Wash.) have all expressed a variety of reservations about paying for the jobs measures on the backs of fund managers. On the House side, high-ranking Democrats have spoken out in two separate closed-door caucus meetings this week against taking the vote against the hedge fund crowd.

"I have, overall, a concern about the carried interest loophole as it relates to both characterization rates and implementation period and I think that we can derive revenue that we want and should need, but I think there is a different way to do it," said Menendez on Tuesday. A Menendez aide said that he wants to ensure that the real estate market is not harmed and that businesses don't lose access to venture capital.

The Private Equity Council has retained Democratic-leaning K Street powerhouse Glover Park Group -- in its own words "an independent, strategic communications firm that delivers research-driven, targeted campaigns that draw attention, shape opinions and inspire action" -- to push the message that there is broad opposition to closing the carried interest loophole. Groups like the Real Estate Roundtable, along with the U.S. Conference of Mayors and the founder of Black Entertainment Television, oppose a "157 percent tax increase on real estate, venture and private equity investment partnerships that provide much-needed capital to America's businesses and entrepreneurs."

Organized labor and MoveOn.org are lobbying hard from the other side. "I don't know how members of Congress can return home and look an office manager, a nurse, a court clerk in the eye and say I chose hedge fund managers instead of you and your family," said the SEIU's Lori Lodes. "But that's exactly what they'll have to do, if they do not pass the jobs package this week. People need jobs and security -- they don't need the people they elected into office putting the richest of the rich first."

Congress as an institution is so dysfunctional that majority support for a bill is not enough to guarantee -- or even make likely -- that it will become law. So preferred policies are attached to what are known as "must pass" legislation. The tax extenders and the war supplemental are two such vehicles, and may be the last two leaving the station during the 111th Congress.

The fix Democrats find themselves in is a consequence of the congressional practice of refusing to make policy permanent and instead requiring programs to be reauthorized year after year. The strategy has twin benefits: the interest group effected by the policy is required to constantly lobby for reauthorization and the budget deficit can be made to look a bit smaller, because the number crunchers assume that when the tax credit or subsidy expires, Congress won't extend it. The money for doctors -- known as the "Doc fix" -- is a prime example. Each year or two, a scheduled cut in Medicare reimbursement rates takes effect if Congress doesn't act to stop it. So doctors lobby furiously to make sure Congress acts. In the summer of 2008, a handful of Republicans blocked the effort to stave off the rate cut and were viciously skewered at home during the Fourth of July break by editorial boards, doctors groups, which are traditionally in the GOP camp, and the AARP. They came back to Washington and switched their votes.

During the health care reform debate, House Democrats hoped to end the charade of the Doc fix and took the annual rate cut out in its bill. But the fix cost billions, according to the Congressional Budget Office. The high price tag took the bill over the arbitrary $900 billion cap Obama had set. It was removed, yet the AARP and the doctors groups endorsed the bill anyway, knowing full well it would continue to be fixed year after year. So today, Democrats are working to attach it to the jobs bill at a CBO-estimated cost of nearly $65 billion over five years. Calling it a "cost," however, obscures what's really happening. Sure, it is a cost, but it's not, in reality an additional cost, unless you're the CBO. Everyone in Washington has long assumed the Doc fix will be made. If it's not, doctors say, it won't be worth it financially for them to treat Medicare patients -- as it is, they barely break even now. And then Washington has angry seniors on its hands.

A solution proposed by Sen. Kent Conrad (D-N.D.) is emblematic of the Washington approach to policy-making. Instead of staving off the cut for five years, as the current proposal would do, just hold it off for two years, he suggests. That "saves" roughly $27 billion. "I favor two years, everything at two years and have the debt commission deal with everything on a permanent basis," Conrad told reporters Tuesday. "Makes sense to me."

Shell games aside, the spending debate is maddening to serious economists, who are in near-unanimous accord that deficit reduction is an issue that can be dealt with in the medium to long term, but in the short term, in the middle of the worst jobless crisis since the Great Depression, what is needed is the economic boost provided by government spending. "[W]e are nearly 8 million jobs short of normal employment and about one trillion dollars -- or 10,000 dollars per family -- short of the economy's potential output and income," White House economic adviser Larry Summers said in a speech on Monday. "Shortfalls in output and employment stunt the economy's future potential as investment projects are put off and as the skills and work habits of the unemployed atrophy. This last point is especially important when, for the first time since the Second World War, the typical unemployed worker has already been out of work for more than six months."

And Mark Zandi, chief economist for Moody's Economy.com and a top adviser to the 2008 presidential campaign of Sen. John McCain (R-Ariz.), testified in April that it's more important to preserve extended unemployment benefits than to worry about what doing so would add to the deficit. "It would be desirable if the costs of the benefits were paid for, not now but in the future once the economic expansion is in full swing," said Zandi. "The greater immediate risk is not that long-term interest rates will rise too high, but that hiring and job growth will fail to revive as anticipated... Costs to taxpayers will be measurably greater if the economy does not turn the corner to expansion but instead retreats back into recession."

Indeed, the CBO reported Wednesday that the stimulus reduced the unemployment rate between 0.7 and 1.5 percentage points and expanded the number of people employed by between 1.2 and 2.8 million.

In February, the Senate approved "paygo" rules that require spending to be offset by tax hikes or spending cuts elsewhere. The way around paygo is to declare spending an "emergency," as President Bush routinely did with war funds. Fudging paygo rules during a recession is a good thing, as far as economists are concerned. The private sector is not yet able to fill that one trillion dollar gap between actual and potential output, leaving the public sector as the only option. But the debate in Washington goes on as if it is the deficit that is responsible for the economic slowdown. The deficit, whatever its long-range consequences may or may not be, has nothing whatsoever to do with the current economic downturn. Exactly the opposite: Stimulus spending and tax cuts in 2009 played a major role in turning around an economy that was shedding nearly three-quarters of a million jobs per month, a staggering and debilitating total that threatened to sink the economy into a depression.

Money for the war is running out and time is short for several provisions of the extenders bill, and not just because of the Memorial Day recess. The Doc fix is needed by June 1, or else doctors will see a 21-percent reduction in compensation for treating Medicare patients. Extended unemployment benefits will also begin to go by the wayside at the beginning of June. The National Employment Law Project estimates that 1.2 million will prematurely lose access to unemployment benefits within 30 days.

Rumors are swirling that Democrats will give up on the larger bills in favor of stopgaps to extend the expiring programs for a short time, though even doing that would likely require senators to stay in session on Saturday. The Senate confronted the same dilemma at the end of March, and Democrats voted to adjourn, disrupting benefits for thousands during a recess.

"People who think unemployment's not a neverending issue simply don't know what they're talking about," said Reid on Wednesday.

Lucia Graves contributed reporting.