Despite a very productive session that included passage of a landmark health care bill and instituted new regulations on the financial industry, Congress left Washington for a five-week recess with a great deal of trepidation as it was gearing up to face a public that is very critical of the actions taken during the last 18 months and very concerned about the country's future. Already we have seen seven incumbent members of Congress lose primary elections to opponents who have found success by tapping into a vein of discontent and unease among voters. Most observers believe that Republicans will make major gains in the November elections and a growing chorus believes that one or both chambers of Congress may switch to Republican control. If this occurs, the ripples from the election will spread out for a long while and may set up the 112th Congress as a 24-month long election campaign for 2012 with Congress and President Obama at odds on nearly every issue. Moreover, should a Republican tsunami hit in November, the growing political power of the Tea Party movement will be a new factor in Washington itself in January and in political campaigns across the nation.

While Congress will have three weeks to deal with legislation, it is unlikely that much will get done during this time as both parties maneuver to gain political advantage before the November mid-term elections. When the Senate returns from its summer break in September, lawmakers will have a full plate of legislation to address: 372 bills to be exact according to The Hill newspaper. Most of these bills will not move ahead. A few items where the parties may reach agreement — food safety legislation, patent reform, aviation law, and one or more spending bills — may get through, but the real action is more likely to come in the lame duck session after the election. However, if there is a major shift of power, not much will happen during the lame duck session, especially if Republicans win one or more of the three Senate seats now held by appointed Democrats. It is important to remember that the last time the Republicans won control of Congress in 1994, the lame duck session after that election was only three days long — a similar election might very well have the same result this time.

Here are our thoughts on what to expect in the areas of taxes and fiscal policy, energy and environment, health care, and the political outlook for the next few weeks and after November 2.

Taxes and Fiscal Policy

Much of the debate this fall will be about how tax policy should be addressed before the end of the year and the resulting effects on the ballooning budget deficit and national debt, in addition to the political fallout from these choices. This falls into three main categories: the fate of the 2001 and 2003 Bush tax cuts, the estate tax and the alternative minimum tax (AMT), and the long-stalled tax extenders bill. A proposal from President Obama to extend the Bush-era tax cuts for taxpayers earning under $250,000 per year while allowing other taxes to rise has been criticized by Republicans who oppose any tax hikes in a weak economy. The Bush tax cuts are scheduled to expire at the end of the year and without any extension, taxes will rise on all taxpayers.

The Senate will take the lead on these bills when Congress returns in mid-September but the Democrats in that chamber are far from unified on what approach to take to reach a deal. Reports have surfaced that moderate Democrats are playing a “leading role” in thwarting the effort to hike income tax rates on the wealthy citing the same arguments as their Republican colleagues. Enactment of any tax bill before the election appears difficult, so final action could shift into a post-election session that will be affected by the election results and the expected mid-December release of a report by the president's fiscal commission that is expected to include tax policy recommendations. This delay on reaching a final deal will likely cause huge headaches for businesses of all sizes as well as for payroll administrators and workers leading into the first months of 2011.

Second, Congress must get a handle on the issue of the estate tax, which expired on January 1, 2010 due to the wrinkle in the Bush-era tax cuts. The tax disappeared this year but is scheduled to increase to 55 percent with only a $1-million exemption, on January 1, 2011. The Senate has worked to find a compromise on the bill but has not been successful. The Obama administration favors a 45-percent estate tax rate with a $3.5 million exemption. The same language was passed by the House of Representatives and included in the 2009 budget proposal but has never passed the full Congress. A bipartisan duo — Sens. Blanche Lincoln (D-Ark.) and Jon Kyl (R-Ariz.) — have championed a proposal to set the estate tax rate at 35 percent with a $5-million exemption phased in over 10 years and indexed for inflation. Most believe that any estate tax deal will involve a retroactivity clause to the beginning of 2010, which may draw court challenges.

On the AMT, there have been efforts to find a way to reform this tax, which has hit a growing number of middle class persons, but the cost of a long-term patch would be very high (approximately $660 billion over 10 years). As a result, Congress has patched the AMT annually, meaning it passes a one-year exemption for most of the Americans the tax would otherwise hit. In 2009, Congress excluded most couples earning a combined $70,950 and less and individuals making $46,700 or less from the AMT. Senate Finance Committee Chairman Max Baucus (D-Mont.) has tried to work on the issue for this year but no deal has yet been reached. This may slip to the lame duck session.

The Senate has tried and failed to move to a vote on a bill that contains $14 billion in tax breaks and enhancements to existing government small-business programs, which has support from both Democrats and Republicans. It also would establish a $30-billion lending fund for small businesses. The bill has been changed several times, each time revised downward to a lower price tag, to try to secure Republican votes to invoke cloture and move to a vote. President Obama has blasted Senate Republicans for blocking the bill and has urged passage noting that the latest bad economic news. Should the Democrats be successful in reaching cloture on the bill, the measure would still have to be cleared by the House in September. Furthermore, President Obama stated during Labor Day week that that he will pursue additional non-stimulus measures to help create jobs, including a $50 billion infrastructure proposal, an expansion and 10 year-extension of the now-expired domestic research-and-development tax credit, and permitting firms to write off 100 percent of spending on new plants and equipment in 2011.

Congress will likely pass one or two appropriations bills (Defense, Homeland Security, and Military Construction and Veterans Affairs are in the lead) prior to the election and cover the rest of the government spending for the new fiscal year in a continuing resolution until after the election. Post election is where the spending story will get interesting. Congress could pass a large omnibus spending measure that will encompass the remaining bills or, more likely, it will choose to pass additional continuing resolutions that could go well into early 2011. These decisions will become clearer as we approach the end of the fiscal year on September 30.

The real effect of this election may be in the fiscal approach going forward. The Tea Party movement has really affected the national debate on taxes, spending, deficits, and debt and will likely be even more influential with a number of their endorsed candidates joining Congress next year. Their political victories and presence on Capitol Hill will serve as everyday reminders to their colleagues about the political price related to fiscal policy and taxes, especially for those senators up for re-election in 2012.

Energy and Environment

The oil spill in the Gulf of Mexico has dominated debate in this issue area since the incident in April caused the largest catastrophe of its kind in the nation's history. While a sweeping climate change bill passed the House last summer, the Senate has become a graveyard for the issue with a sizable Democratic block joining with all Republicans to stop legislation. Even a long-awaited draft compromise climate change legislation from Sens. John Kerry (D-Mass.) and Joe Lieberman (ID-Conn.) unveiled in May died an unlamented death just weeks later. A smaller package of energy and oil-spill response bills was rolled out by Senate Majority Leader Harry Reid (D-Nev.) later in the summer but he delayed further consideration of the bills until September.

Despite the failure of Senate Democrats to bring up a comprehensive climate change bill so far this year, a senior White House official has said that Congress still has time to pass a measure this year in the post-election session in November. White House Climate and Energy Czar Carol Browner said on NBC's “Meet The Press” on August 8 that while the Obama administration is "deeply disappointed" that an energy bill was unable to make its way through Congress, the president has not given up hope that it can get done this year. In June, the plan to use the lame duck session for passing a final version of a climate bill was raised. The first step is to have the Senate pass a bill which can then be sent to a conference committee where it can be merged with the House version with the resulting compromise measure to emerge after the November 2 election for a vote in both chambers.

It is likely that the Senate will attempt to move on the Reid package later this year — especially the portions dealing with oil-spill cleanup and expanded liability — but the energy package may be more contentious given the potential lame duck strategy and the opposition to the concept of taxing carbon, which is easily translated to even further damage to the fragile economy.

Health Care

After passing the largest overhaul of health care since the enactment of Medicare in 1965, Congress has been working to address related issues to the program to provide health care to seniors. A bill (H.R. 5297) to fix the long-troubled Medicare physicians' fee schedule that passed the House was bogged down in the Senate over its large cost ($210 billion over 10 years). A smaller version was attached to a bill of tax breaks for small business but weighed down that bill so much that it was stripped out and passed as a stand alone six-month extension in June. Congress will likely not want to revisit the program over the long term and will punt the issue to the next Congress.

Next, the administration is working to implement the health care reform bill as Republicans plan for their offensive to repeal the Patient Protection and Affordable Care Act or “Obamacare” bill and seek to find new solutions to the issue. The measure, which was enacted in March, gained some traction with the public in the intervening months, but has subsequently fallen back to its pre-enactment levels. A CNN poll from August shows that 56 percent of Americans oppose the health-care law, with only 40 percent in support and Rasmussen's latest poll of likely voters shows that 56 percent want the bill repealed. The political ramifications of the bill's unpopularity has resulted in national Democrat strategists advising incumbents to talk about “improvements” to the system rather than cost savings during August town halls according to a report in POLITICO.com.

Finally, Congress is likely to revisit, during the September session, a food safety bill that has been stalled in the Senate. Just after the recess began, senators announced that a deal to move the bill had been reached. The agreement does not include a ban of the chemical bisphenol A (BPA) from plastic infant bottles and children's cups, which had been sought by opponents who question the safety of the chemical. The food industry, which supports the Senate bill (S 510) approved by committee last fall and the House-passed legislation (HR 2749), had threatened to fight any measure that banned BPA.

Political Outlook

Traditionally, the first mid-term election after a president's election results in losses for that leader's party in Congress, and this election looks to be different only in the magnitude of the potential losses. The possibility that the Democrats could lose at least one chamber of Congress is quite large and there is an outside chance that both chambers could flip. According to an analysis by Congressional Quarterly, there are 36 House seats listed in the “tossup” category with all but two seats on that list now held by Democrats. Republicans need 39 more seats to take control of the House and several experts believe that this change is becoming more likely by the day. An analysis of the race put forth by noted political expert Larry Sabato of the University of Virginia noted that Republicans have a good chance to win as many as 47 seats if trends continue and that observers may have been “conservative in estimating the probable GOP House gains.” And, even if Republicans do not win a majority of the seats, Speaker Pelosi's agenda will come to a dead halt with fiscally conservative Democrats unwilling to toe the party line.

Across the Hill in the Senate, Congressional Quarterly lists 12 seats in the “tossup” category with eight Democrats and five Republicans represented. One Democratic-held seat (North Dakota) is already listed as “Safe Republican” and, with this addition, reduces the number of seats needed for the GOP to take over that chamber to eight. The Cook Political Report's current outlook is for a Republican pick-up of between seven and nine Senate seats with Prof. Sabato picking the middle position of eight seats.

Democratic Party leaders are seeing the same numbers and trends and are rightfully concerned about their party's chances in the November elections. A recent Gallup poll testing the so-called “generic ballot” found that the House Republican candidate out-polled the House Democratic candidate by a 10 percent margin (51 percent to 41 percent) among registered voters, which is the largest lead in Gallup's history of tracking the midterm generic ballot for Congress. In comparison, the highest such gap previously measured was five percent, measured in June 2002 and July 1994, years when Republicans made significant gains in House elections. Additionally, the same survey found that Republicans are now twice as likely as Democrats to be "very" enthusiastic about voting this fall. The results of the 2006 and 2008 elections have created a number of seats now held by Democratic House members in which Republican voters hold an advantage. The existence of this “low hanging fruit” almost ensures that Republicans will gain seats.

Moreover, the right track-wrong track number in the Time poll is another ominous warning with 57 percent respondents saying the nation is on the wrong track while only 34 percent think it is on the right track. Dissatisfaction with the status quo and concerns about the sluggish economy and the lack of job creation puts Democrats in a very difficult situation as they hold all the levers of power in Washington. The hoped-for economic rebound has not yet materialized and, while jobless claims have fallen, the unemployment rate is still at 9.5 percent.

While it seems that the Republicans have a favorable wind at their back, it remains to be seen if their course is on the right track to take full advantage. The party's favorability ratings (30 percent approve and 67 percent disapprove) are even lower than the Democrats (37 percent approve and 61 percent disapprove) in a recent AP poll with similar right track-wrong track findings. However, independents have been breaking more toward the Republicans in recent polling and this may provide a large boost to the fortunes of the GOP on Election Day. Additionally, the recent Gallup poll shows that Republicans hold advantages over Democrats in seven of nine critical issue areas including terrorism, immigration, spending, the economy, Afghanistan, jobs, and taking on corruption.

Bear in mind that we are less than sixty days away from Election Day and, while the possibility of a game-changing event occurring in that time is not impossible, the current trajectory of the elections seems to be in favor of a large Republican victory that will fundamentally alter the political landscape of Washington. The continued drag of the economy, in spite of all the stimulus spending is a major factor in the dissatisfaction with Democrats and incumbents. And, this change in political landscape will result in legislative changes that will challenge President Obama as he looks towards re-election

We will continue to monitor developments and are available to provide advice and counsel to you and your clients on these and other specific issues.