Barack Obama is bowing to Republican demands to extend a deep tax cut for wealthier Americans, to the fury of some of the president's allies who say he has succumbed to "blackmail".

In a bruising political battle that appears to set the tone for Obama's dealings with the Republicans in Congress following their victories in last month's midterm elections, the president had sought to extend a tax cut for middle-class Americans introduced by the Bush administration seven years ago which expires at the end of this month. But he wanted to see a return to pre-cut rates for households with an income above $250,000 a year, on the grounds that wealthier Americans could afford to pay more. The move would generate trillions of dollars for the financially-strapped treasury over the next decade.

The Democratic leadership believed that provided the middle class was looked after, the Republicans would find it difficult to justify tax cuts for the wealthy. The House of Representatives, still controlled by Democrats until the new Congress is sworn in next month, passed Obama's plan by a clear majority last week. But Republicans blocked the legislation in the Senate at the weekend and said they would rather see everyone's taxes rise than agree to scrapping the cuts for the wealthy.

Some Democrats called on Obama to stand firm and let the Republicans carry the blame for the inevitable middle-class backlash. But leading Democrats say the president is backing down and has agreed to extend tax cuts for everyone. In return, the White House appears to have extracted an agreement to extend benefits for the long-term unemployed.

Today Obama said that his priority is to "prevent the middle-class tax increase" that would have come about if there was no agreement. "There's some serious debates that are still taking place. Republicans want to make permanent the tax cuts for the wealthiest Americans.

"I have argued that we can't afford it right now. But what I've also said, we have to find consensus here because a middle-class tax hike would be very tough not only on working families, it would also be a drag on our economy at this moment," he said. "We've got to make sure we're coming up with a solution, even if it's not 100% of what I want or what the Republicans want."

Leading Democrats did not hide their frustration at the president's backtracking. Senator John Kerry, the former presidential candidate, accused Republicans of holding the country hostage.

"They've said, 'No, we are willing to hold that hostage so that we can give the wealthiest people in the country a bonus tax cut'," he said.

The outgoing House speaker, Nancy Pelosi, is reported to have expressed deep unhappiness at the deal, saying the White House gave in too easily to Republican pressure. Richard Durbin, the second highest ranking Democrat in the Senate, said the agreement to extend the tax cuts for the wealthy was "against my judgment".

Paul Krugman, the Nobel economics prize winner, called on Obama to stand firm against the Republicans' "tax-cut blackmail" which will cost the US treasury $4 trillion in revenue over the next decade and prompt a "major fiscal crisis".

"If Democrats give in to the blackmailers now, they'll just face more demands in the future. As long as Republicans believe that Mr Obama will do anything to avoid short-term pain, they'll have every incentive to keep taking hostages. If the president will endanger America's fiscal future to avoid a tax increase, what will he give to avoid a government shutdown?" Krugman wrote in the New York Times.

But Larry Sabato, a political scientist at the University of Virginia, said that Obama had little choice but to make a deal.

"The Democrats generally haven't adjusted to the fact that they lost the election badly. That's fundamental and they haven't accepted it. Republicans designated maintaining tax cuts as their top priority," he said.

"The Republicans have pulled it off at the right moment. It's immediately after the election with two years to go before the next election. So the Republicans are getting to please their constituency which believes in that from top to bottom - not just the rich but their middle-class members - without suffering any real electoral consequences. That's why Obama caved. In the end, everybody's taxes would have gone up. Republicans would have held to this and blamed Obama."

Sabato said that the confrontation over taxes sets the tone for Obama's dealings with the Republican-controlled House of Representatives and an increasingly belligerent Republican leadership in the Senate next year.

"This is going to be a very inflexible Republican congress," he said.

In a statement from the White House last night, Obama sought to explain to the American people how he had come to agree to what many in his own party decried as a humiliating climbdown. He said that he had with regrets accepted compromise in order to spare millions of struggling Americans further pain in the form of rising taxes.

Obama made no attempt to disguise his contempt for the Republican position. He said he "completely disagreed" with their insistence that the Bush tax cuts for the wealthiest two per cent of Americans were made permanent.

"Economists from all across the political spectrum believe giving tax cuts to millionaires and billionaires does very little to grow our economy."

But he said that he felt he had no option but to swallow that element in order to loosen the Republican stranglehold which would have seen two million Americans lose their unemployment benefits by the end of this month and millions more face rising taxes.

"What is abundantly clear to everybody in this town is that the Republicans will block a permanent tax cut for the middle class unless they also get a permanent tax cut for the wealthiest Americans."

He conceded that the compromise would be unpopular equally among his supporters and opponents. But he said "I'm not willing to let working families across this country become collateral damage for political warfare here in Washington." "I think this is a symptom of the weakness that was produced November 2 which in turn was a symptom of the weakness produced by a bad economy and Obama's decisions."

Bush tax cuts

George Bush passed two major tax cuts that were portrayed by critics as gifting large amounts of money to the wealthiest Americans. The second round of cuts, in 2003, reduced taxes across the board from individual income tax to capital gains and estate tax. The move was controversial and the legislation only passed the Senate after Bush's vice president, Dick Cheney, cast a deciding vote.

The tax cuts expire at the end of this year. Republicans campaigned in last month's midterm elections to maintain the cuts for all tax payers. Barack Obama said he would keep the benefit for middle-lass households with a total income below $250,000 a year but that the better off should pay higher taxes at a time when the US is sinking deeper in to debt.

By some estimates, maintaining the reduced rate for households on more than $250,000 a year will cost the US government about $4tn in income over the next decade. But earlier this year Deutsche bank concluded that letting the Bush-era tax cuts for wealthier Americans expire would significantly slow economic growth.