WASHINGTON (Reuters) - The Senate on Saturday approved a two-month extension of a payroll tax cut and a $1 trillion bill to fund the government, resolving the latest in a year-long series of tense political stand-offs but setting up fresh battles for 2012.
Democrats and Republicans were unable to agree on how to pay for a full-year extension of the tax cut and long-term unemployment benefits, as President Barack Obama requested. So senators settled, by a vote of 89-10, for a short-term measure that sets up a debate early next year - just as presidential and congressional election campaigns kick into high gear.
"It would be inexcusable for Congress not to further extend this middle class tax cut for the rest of the year," Obama said at the White House shortly after the Senate passed the bill. Senators then left town, to return for business on January 23.
The payroll tax cut bill keeps the 4.2 percent tax rate from jumping to 6.2 percent for 160 million workers on January 1.
Economists have warned that a failure to keep the workers' tax cut in place next year would hurt a U.S. recovery already exposed to troubles in debt-stricken Europe. Some said it could lop as much as 1 percentage point off economic growth.
While it is far too early to know how Congress would address the issue in two months, it will be politically difficult for Congress to allow workers to be hit with a 2 percent payroll tax increase with elections approaching.
But first the House must address the Senate's two-month extension bill. A House Republican aide said leaders spoke by telephone with rank-and-file members and a few options were discussed. Those include accepting the Senate bill or amending it and sending it back to the Senate.
While no decision was made, the aide said members were "overwhelmingly disappointed in the Senate's decision to just kick the can down the road for two months."
The $33 billion cost of the two-month extension would be covered by increasing fees government-controlled Fannie Mae and Freddie Mac charge lenders to guarantee mortgages. A full-year extension would have cost about $200 billion.
The fees on new mortgage customers would be permanently increased by 10 basis points under the legislation.
In a year that saw relentlessly partisan fights over budget, tax and debt legislation, the struggle over the payroll tax cut and jobless benefits measure was a final bruising battle that could set the tone for 2012.
This year, difficulties crossing the partisan divide brought the government to the brink of shutting down three times, pushed it close to a debt default and cost the nation its prized triple-A credit rating.
The $915 billion spending bill that cleared the Senate 67-32 ensures the government will keep running through next September. Obama signed it into law late on Saturday.
It raises funding for the Defense Department but cuts into budgets at the Environmental Protection Agency, education and health departments and other federal activities.
Congress worked up to the wire to finish the legislation, as agency funds were running out this weekend and federal workers faced layoffs.
It has been such a tough year that Senate Majority Leader Harry Reid turned to history to try to put it into perspective.
Reid recounted the 1856 beating in the Senate chamber of a Massachusetts senator by a member of the House. "The times that we are going through here are not unusual for the United States Senate," Reid said. "In fact they're very peaceful and calm compared to some times."
Republicans used the tax bill to push for quick U.S. approval of TransCanada Corp's Keystone XL pipeline project, which is backed by labor unions but opposed by environmental groups.
The legislation requires Obama to approve construction of the pipeline from Canada to U.S. Gulf of Mexico facilities within 60 days or declare it is not in the national interest. Obama wanted to take a year, beyond November's elections, to review the project.
Republicans argued the pipeline would create jobs at a time the nation is suffering from an 8.6 percent unemployment rate.
"The president says he wakes up every morning thinking about jobs. This morning, the Senate took action where the president has punted," said Republican Senator John Cornyn.
Democratic Senator Charles Schumer characterized his party's concession on Keystone as giving Republicans "the sleeves off a vest" since the State Department already has said it would withhold approval if forced to fast-track a decision.
An Obama administration official who briefed reporters said the State Department would "almost certainly" have to turn down the approval because there would not be enough time to complete its environmental review.
The decision to pay for the continued tax cut and jobless benefits with the guarantee fees Fannie Mae and Freddie Mac charge will drive up mortgage costs for homebuyers.
For example, the cost of a $220,000 mortgage would go up by about $15 per month, according to Obama administration calculations.
The administration had proposed raising the fees as a way to slash the federal budget deficit and reduce the government's role in the housing market, where it now finances about nine in 10 new mortgages. An administration official said gradually increasing the fees would encourage more private financing.
Additional reporting by Laura MacInnis and Caren Bohan; Editing by Eric Walsh