Beyond the question of what led still-unidentified IRS agents to use what an audit called “inappropriate” criteria in reviewing conservative groups, the rise of tax-exempt groups in American politics is at the core of the scandal.

At issue is how people on both sides of the nation’s political divide have formed hundreds of nonprofit, tax-exempt groups under Section 501(c)(4) of the IRS Code. U.S. law does not require them to disclose their donors and says they must operate “exclusively for the promotion of social welfare.”

Under Treasury regulations used for decades, however, the law has been defined to mean that such groups must “primarily” be concerned with social welfare causes, such as “bringing about civic betterments.”

That has created enough wiggle room for a new generation of 501(c)(4) groups that are largely dedicated to political causes – their version of “civic betterment” – without specifically endorsing any political candidates, which the IRS forbids.

Such 501(c)(4) groups have been big players in recent elections, spending hundreds of millions of dollars to influence voters.

A deluge of applications from conservatives in the last three years led the IRS to inappropriately target groups with names such as “Tea Party” and “Patriots” for extra scrutiny.

As the Senate Finance Committee grilled outgoing IRS chief Steven Miller and former IRS Commissioner Douglas Shulman on Tuesday, Democrats on the panel said that expecting the IRS to determine whether groups are too political to be tax-exempt was too much to ask the tax agency.

They said the law should be interpreted as it was originally intended, and that “social welfare” groups should not be allowed to be political at all.

“Notwithstanding the troubling and unacceptable conduct of the IRS, if political organizations do not want to be scrutinized by the government, they shouldn’t seek privileges like tax-free status and anonymity for their donors,” Democratic Sen. Ron Wyden of Oregon said.

Wyden added that it has become apparent that groups that ought to be “527″ organizations – tax-exempt, politically active groups that must disclose their donors – are applying for 501(c)(4) status to avoid having to reveal their contributors.

“That’s a loophole the Congress ought to close,” Wyden said.

‘TWO SCANDALS HERE’

As Republicans continued to press Miller and Shulman over whether partisanship was behind the agency’s actions, other Democrats on the Senate panel echoed Wyden.

“I think there are two scandals here,” New Jersey Senator Robert Menendez said. “One is the (IRS’) management failures and the whole process of singling out specific groups. The other is how we take statutory authority and then extrapolate it differently than what the Congress meant.”

Conservative leaders such as Karl Rove – a Republican strategist who helped found Crossroad GPS, the nonprofit that spent more than $50 million on the 2012 elections – have said they view 501(c)(4) groups essentially as equalizers for conservatives: a way to help them match Democrats’ fundraising from organized labor and other big groups.

J. Russell George, the Treasury inspector general who last week issued the audit that described the inappropriate conduct by the IRS, told the Senate panel that his office was launching a broader probe into the IRS’ oversight of 501(c)(4) groups.

Senator Max Baucus, a Montana Democrat and chairman of the panel, said recent elections have shown that, “clearly, a Mack truck is being driven through the 501(c)(4) loophole.”

Baucus then chided Shulman, whom the senator accused of not responding to senators’ concerns in 2010 about how 501(c)(4) groups would be handled.

“You were on notice, and you did acknowledge you’re on notice, but nobody did anything about it,” Baucus said. “I’m just quite disappointed.”

Shulman responded by calling for clearer laws and regulations regarding tax-exempt groups, a rare moment of agreement between him and senators.

“The IRS is given a very, very difficult task of trying to go in and figure out” whether groups are involved in too much political activity to remain tax-exempt, Shulman said.

“The confusion and breakdown that you saw happen in the Cincinnati office is inexcusable, but … at least this is my belief, that part of it was because of the very difficult task given to these people.”

A LOW REJECTION RATE

According to a recent report by the Center for Responsive Politics, the IRS’ rate of rejection of applications for groups seeking tax-exempt status is low.

From January 2007 through September 2012, the center estimates, 26 to 28 applications were denied, though other groups may have withdrawn their applications if a rejection were pending.

The IRS’ 2012 Data Book indicates that it rejected eight of 2,774 applications from such groups that year.

Conservative groups have complained to Congress about overly aggressive enforcement by the IRS, including demands from the tax agency that the groups answer questions about their donors and any members’ plans to run for public office.

But advocates of greater scrutiny of tax-exempt groups fear that the IRS scandal will discourage the tax agency from aggressively challenging applications for tax-exempt status.

“The institutional lesson (the IRS) is learning is that when they push on something in the political sphere, they get smacked,” said Arn Pearson, vice president for policy and litigation at Common Cause, a liberal advocacy group. “My concern is that what they’re going to do is just really back off, and not do any meaningful enforcement.”

(Editing by Fred Barbash and Stacey Joyce)

Three months after Republicans failed to oust Democratic President Barack Obama from the White House, Rove, Gingrich and other Republicans are locked in an increasingly bitter debate over how to revamp their party to appeal more to women and minorities.

The latest in a series of spats surfaced on Wednesday, as Gingrich gave a blistering critique of Rove’s plan to create a fundraising group aimed at boosting moderate Republicans in congressional races – and blocking the rise of far-right conservative candidates.

“Handing millions (of dollars) to Washington-based consultants to destroy the candidates they dislike and nominate the candidates they do like is an invitation to cronyism, favoritism and corruption,” Gingrich wrote in the conservative magazine Human Events. He also chided Rove – a former top aide to President George W. Bush – for his work in several losing races last fall.

Gingrich’s shot at Rove reflected the tension that has been building among Republicans since the November 6 elections, when Obama won with big margins of support from women and minority groups, including the fast-growing Hispanic population. It was the fifth time in the last six presidential elections that the Democratic candidate got the most votes.

Since then, Republican strategists say, their party has been wrestling with two questions: Has our message gotten too conservative for an increasingly diverse and moderate national electorate? Or, is it just the way we’ve been selling it?

The effort to answer those questions helps explain much of the party’s political maneuvering since the election.

It’s why conservative leaders who believe there is nothing wrong with the party’s low-tax, limited-government message are looking beyond Washington’s gridlock to emphasize places where tax-cutting Republicans are showing more promise: at the state level, namely the 24 states where Republicans control the governor’s office and the legislature.

And it’s why, even amid the partisanship in Washington, there have been gestures toward the political center that would have been difficult to imagine just a few months ago.

Four Republicans in the Senate, including Marco Rubio of Florida, joined four Democrats in proposing an overhaul of the nation’s immigration laws. Some conservative Republicans, including House Majority Leader Eric Cantor, have indicated they would back a path to citizenship for children of illegal immigrants, an issue that for years has been a non-starter among conservatives.

Republican leaders in Congress have sought to tamp down internal rebellions over fiscal issues and harsh rhetoric on immigration and abortion that led some voters in November to see Republicans as obstructionists in Congress, anti-immigrant and anti-women. House Speaker John Boehner removed four fiscally conservative lawmakers from powerful committees in December.

And this month, Rove’s American Crossroads “Super PAC” announced that it was forming the Conservative Victory Project to recruit more moderates to run for high office.

Rove acknowledged that the idea behind the new group was to avoid having candidates such as Representative Todd Akin of Missouri and Richard Mourdock of Indiana, Senate hopefuls last year who were backed by the conservative Tea Party movement.

During their campaigns, Akin and Mourdock, both of whom oppose abortion rights, made comments about rape that helped to sink their chances for election. Akin resisted calls to withdraw from his race after saying that victims of “legitimate rape” rarely get pregnant.

The comments by Akin and Mourdock were among several by conservative Republicans that often were cited by Democrats who accused Republicans of waging a “war on women.”

“It’s amazing that people think Todd Akin was the best we could’ve come up with,” Rove said on Fox News. “We need to get better conservative candidates and win.”

TARGETING ROVE

It is not unusual for a party to try to “re-brand” itself and its message after losing a presidential race.

But many staunch conservatives and Tea Party-backed Republicans are dismayed by efforts to reach out to Democrats or compromise on any front.

During the past two weeks, Rove and his new group have been a popular target for such Republicans.

Iowa Governor Terry Branstad called Rove’s move a “mistake.” Former Representative Joe Walsh of Illinois, a Tea Party favorite who lost his bid for re-election in November, said he plans to launch a conservative fund-raising group to battle Rove’s group and “fight for the soul of the Republican Party.”

And Akin, defending his campaign from Rove’s criticisms, accused the strategist of trying to “get rid of conservatives.”

Meanwhile, a Tea Party group that had sent out a fund-raising e-mail with an altered photo showing Rove in a Nazi military uniform apologized to him on Tuesday, saying that a vendor had doctored the photo without the group’s approval.

Rove said he does not want to fight with the Tea Party and other conservative groups, and that he is simply trying to put Republicans in position to win elections.

That sentiment was echoed by Republican strategist Ron Bonjean.

“With a void of power after the election, the struggle between pragmatists versus purists on electing Republican candidates seems inevitable,” Bonjean said. “However, it’s not about being conservative or moderate. The best conservative with the best chance of winning the election should have the backing from everyone.”

WATCH THE GOVERNORS

In recent weeks, Republicans have made a point of touting their efforts on the state level as models for how the party can improve its appeal to voters on a national level.

Republicans now hold the governor’s office in 30 of the 50 states. In 24 of those states, the legislature also is controlled by Republicans.

Party strategists say that anyone looking for clues about what they will emphasize in coming elections should examine states such as Michigan and Louisiana. If they are a guide, Republicans’ long-term strategy does not include backing away from conservative platforms.

In Michigan, Governor Rick Snyder champions “right to work” laws that limit unions’ rights, measures that Republicans say boost economic development.

Louisiana Governor Bobby Jindal is seeking to eliminate the state’s personal and business income taxes, and replace them with more sales taxes.

Jindal says the plan would expand the state’s tax base, create more revenue and boost the economy.

In Indiana, former congressman and new governor Mike Pence has made cutting the state’s income tax by 10 percent a legislative priority. And in Kansas, Governor Sam Brownback is pushing to eliminate the state’s income tax. Both support raising sales taxes.

Democrats and other critics say the emphasis on sales taxes would shift more of the tax burden to lower-income people while reducing taxes on the wealthy.

But Republicans counter that tax-cutting measures will have broad appeal – and ultimately help Republicans win more support among women and minorities – because they will stimulate the economy and create jobs.

“It’s the governors who are coming up with good, creative ideas,” said New Hampshire Republican strategist Dave Carney, who advised Texas Governor Rick Perry’s presidential campaign.

Joe Allbaugh, who managed George W. Bush’s presidential campaign in 2000, agreed.

“I don’t see anybody in Washington who is going to catch fire” in the next presidential race, Allbaugh said. “It’s very likely that the positions taken by a handful of Republican governors will determine the shape of the party’s … positions for 2016.”

(Editing by Marilyn W. Thompson and Lisa Shumaker)

Obama’s victory, however, did not settle that question.

Instead, the hard-fought battle for the White House exposed an electorate deeply divided by race, age and party.

Tuesday’s elections – in which Republicans kept control of the U.S. House and Obama’s Democrats held on to the Senate – suggested that bitter partisanship would likely remain very much alive in Washington in the new year. They also revealed that there was no broad mandate for much beyond the broadly shared goals of improving the economy and reducing government debt.

That means that undertaking bold new initiatives comparable to healthcare reform, financial regulation and economic stimulus programs will be a great deal more complicated for Obama 2012 than they were for Obama 2008.

Even so, Obama – now unfettered by not having to face voters again – is in position to pursue an ambitious agenda that could leave his mark on government for a generation or longer, including a move to revamp the nation’s immigration laws.

Some analysts believe Obama is likely to spend much of his second term “locking down the achievements of his first term,” including ensuring that “we will have a functioning national healthcare system,” said Cal Jillson, a political science professor at Southern Methodist University in Dallas.

For some, that would be enough to secure his place in history.

“Just by re-electing Obama, that means the Affordable Care Act will continue to be implemented, and that’s very important because that’s one of the most important pieces of legislation in half a century,” Theda Skocpol, a political scientist at Harvard University, said of the law that helps extend health coverage to millions of uninsured Americans.

“Most of the action will occur between the president’s administration and states, and my guess is a lot of the Republican governors will find ways to accept parts of the Medicare expansion,” Skocpol said.

A BOOST FROM THE BAILOUT?

In at least one respect, Tuesday’s election results vindicated Obama’s belief in an activist government.

By supporting an $85 billion federal bailout of the auto industry in 2009, a measure that was not particularly popular at the time, Obama may have helped to save not just the industry, but his presidency.

The auto bailout – and the Obama campaign’s attacks on Romney over his opposition to it – appeared to be key factors in the president’s victory in the crucial battleground state of Ohio, where 1 in 8 jobs is connected to the auto industry.

Nationwide, Obama – the nation’s first black president – trailed Romney among working-class white male voters by 17 percentage points, according to Reuters/Ipsos Election Day polling.

But in Ohio, white men with incomes of $75,000 or less were split 49-49 between Obama and Romney in Reuters/Ipsos polling. Analysts said the disparity indicated that the auto bailout – which saved nearly 1.5 million jobs nationwide, according to the Center for Automotive Research – likely gave Obama a critical boost in just the right place.

“While Romney enjoys a large advantage among lower-income white males nationally, the trend reverses in Ohio,” Ipsos pollster Julia Clark said. “This underlines the importance of the auto bailout in Ohio, and perceptions of Romney as unsympathetic to the challenges faced by the working class in this state.”

SECOND-TERM AGENDA

Political analysts and strategists expect Obama’s second-term agenda to be layered with increased federal spending for education, job and energy programs.

But such an agenda will be complicated by the government’s $16 trillion debt and the looming “fiscal cliff” – a $600 billion tax increase scheduled to take effect along with mandatory spending cuts at the start of the new year unless Obama and Congress can agree on a deficit reduction deal.

Obama’s commitment to immigration reform – a key goal for Democrats who want to solidify their hold on the growing Latino vote – would seem to have an increasingly clear path to success, especially as Republicans seek ways to improve their appeal to that minority group.

But the biggest, most immediate challenge is the looming showdown with Republicans in Congress over spending and taxes, during which Obama will press to keep his campaign promise to raise taxes on the wealthy while retaining lower tax rates for others.

Obama has signaled he may try to force Republicans to accept his demand to increase taxes on those making $250,000 or more a year by threatening to veto any legislation aimed at preventing the tax increases and massive spending cuts that are slated kick in automatically at the end of the year.

The notion that one of Obama’s boldest second-term moves could be reinstating Clinton-era tax rates on the wealthy suggests that the president’s agenda could be significant but limited, some analysts say.

“It’s not like you’re going to have a new, New Deal,” said Julian Zelizer, a professor of history and public affairs at Princeton University, referring to the broad array of social programs enacted by President Franklin D. Roosevelt to help the nation recover from the Great Depression of the 1930s.

During the presidential campaign, “the rhetoric is so dramatic, you think you’re deciding between FDR and a (staunchly conservative) candidate from the 19th century,” Zelizer said. “I’m sure most Republicans see Obama as a big-government liberal and most Democrats see Romney as a right-wing, Tea Party zealot.”

In fact, Zelizer said, both Obama and Romney were “relatively in the middle of the political spectrum, with limits on what they (could) achieve in a gridlocked Washington.”

CHALLENGE FOR REPUBLICANS

It may be too soon to tell whether the 2012 election will be a turning point in how Americans view the role of government in society. But the election does appear to mark another type of political transition.

Romney, 65, could be the last Republican of his generation to make a serious bid for the White House. The Republicans who appear to be in position to run for president in 2016 represent a new generation of leaders who generally are more conservative than their predecessors.

They include Romney’s running mate, Wisconsin Representative Paul Ryan (42), Florida Senator Marco Rubio (41), Louisiana Governor Bobby Jindal (41), former Pennsylvania Senator Rick Santorum (54), New Jersey Governor Chris Christie (50) and House of Representatives Majority Leader Eric Cantor of Virginia (49).

For them and any other Republicans who might consider a run for the White House, Tuesday’s election results brought a sign of potential trouble ahead.

Obama won about 66 percent of the vote among Hispanics, who make up about 17 percent of the U.S. population and are projected by the Pew Research Center to account for nearly 30 percent by 2050.

The Republican Party’s harsh stance on immigration has hurt its ability to attract Latinos, according to analysts who say the new generation of Republican contenders will need to tone down the party’s harsh rhetoric on immigration or risk certain defeat in several states because of Hispanics siding with Democrats.

“We certainly seem to be at the end of something, and at the beginning of another, when it comes to Republican candidates,” SMU’s Jillson said. “The Republican Party is untenable in its current form and in serious trouble as a viable governing vehicle (because) the Democratic Party is more attractive to growing constituencies – anyone who feels vulnerable and as if they may need support.”

During the campaign, Obama signed an executive order granting temporary legal status and work permits to young undocumented immigrants brought to the United States as children. He also has said he would push Congress to pass the DREAM Act, which would make the order permanent and create a path to citizenship for many undocumented workers.

Romney said he opposed the DREAM Act and that he favored harsh immigration policies that would lead illegal immigrants to “self-deport.” He later seemed to back away from that stance, and said he would seek some form of immigration reform that tied U.S. citizenship to education and jobs.

If Republicans do not improve their image among Latinos, Jillson said, some solidly conservative states might not be that way much longer.

“The Republican Party absolutely will have to soften its message,” Jillson said. “Texas (now dominated by Republicans) is 15 years away from a two-party system” because of its growing Hispanic population.

(Additional reporting by Gabriel Debenedetti; Editing by Jim Gaines and Peter Cooney)

The law – which requires most people to buy health insurance – bans insurers from denying coverage to children with pre-existing medical conditions. It eliminates lifetime caps on essential benefits, allows young adults to stay on their parents’ insurance until age 26, and can make prescriptions less expensive for people on Medicare, the nation’s health insurance program for those 65 and older.

Even so, Republicans have been able to sway public opinion against the law, in part by casting it as a “job killer” that stifles hiring by raising costs to employers.

But at their convention this week in Charlotte, Democrats showed signs of grasping an effective strategy to sell the healthcare law that Romney has vowed to repeal if he is elected November 6.

Tuesday’s session featured emotional testimonials for “Obamacare,” including one from Stacy Lihn, a mother who said the law will allow her family to afford caring for their young daughter, Zoe, who was born with a congenital heart defect.

“Romney repealing healthcare reform is something we worry about literally every day,” Lihn said. “Zoe’s third open-heart surgery will happen either next year or the year after. If Mitt Romney becomes president and Obamacare is repealed, there’s a good chance she’ll hit her lifetime cap.”

The tears on delegates’ faces made it clear: Democrats had found a simple and touching way to cut through the density of Obama’s signature legislative achievement.

“Expect to see more (Obamacare testimonials) this fall,” one Democratic strategist said.

Here’s a look at some other key themes to emerge during the Democratic National Convention:

**When it comes to 2016, Democrats have a bench, too.

In Tampa last week, Republicans rolled out a new generation of potential contenders for president in 2016.

They included Florida Senator Marco Rubio, 41, and Wisconsin Congressman Paul Ryan, 42, who is Romney’s vice presidential running mate but could be in play for 2016 if Romney loses in November.

This week in Charlotte, a few Democrats rose to the moment.

San Antonio Mayor Julian Castro, 37, Massachusetts Governor Deval Patrick, 56, and Newark (New Jersey) Mayor Corey Booker, 43, delivered stirring convention speeches – and signaled that part of Obama’s legacy could be helping to position other minorities to make runs at national office.

Booker neatly summarized the anger that many Democrats feel toward Republicans who portray efforts to make the nation’s wealthiest citizens pay more in taxes as “class warfare.”

“Being asked to pay your fair share isn’t class warfare,” Booker said. “It’s patriotism.”

**How different is 2012? Republicans are talking less about foreign policy, and Democrats are organized.

At the Republican convention that Romney’s team put together in Tampa, Florida, last week, the primary focus was bashing Obama’s stewardship of the weak economy.

Less prominent – aside from a much-praised speech by former Secretary of State Condoleezza Rice – was foreign policy.

It’s traditionally a Republican priority, but isn’t getting as much attention this year, partly because Romney and Ryan have little foreign policy experience and any debate on the subject inevitably leads to Obama’s success in overseeing the demise of Osama bin Laden.

In Charlotte, Democrats bucked a tradition of their own.

Democratic conventions often have been raucous, disorganized affairs, complicated by various special interests grappling for power in the large, diverse party.

This year, it appeared most everyone was on the same page.

The convention featured memorable speeches (particularly by former president Bill Clinton, President Obama and first lady Michelle Obama), and tightly choreographed messaging on themes such as helping the middle class, abortion rights and support for Obama’s healthcare overhaul.

Divisions remain: Some Democratic activists say the party, in its focus on the middle class, is not devoting enough attention to the needs of lower-income families.

And there was the divide over the party’s platform that led to an embarrassing re-vote on the document to insert a mention of God and language recognizing Jerusalem as Israel’s capital.

The vote took place after Obama expressed his dissatisfaction that the approved platform had omitted both, and as Republicans began to air commercials criticizing the Democratic platform.

Through the years, U.S. presidents have expressed support for making Jerusalem the capital of Israel, but have not moved the U.S. Embassy from Tel Aviv because of a belief that the future of Jerusalem should be decided through talks between Israelis and Palestinians.

Even so, declaring Jerusalem the capital is a signal of support for the most important U.S. ally in the Middle East, and is a nod to the influential Jewish-American community.

**Bill Clinton isn’t going away.

In his speech Wednesday night, the former president showed why many people consider him the most talented politician of his generation.

His folksy, methodical breakdown of the Democratic positions on healthcare, Medicare, taxes and other issues also showed why he could be valuable surrogate for Obama in the next two months.

Hours after Clinton’s speech, Obama’s team said the former president would campaign for Obama next week in Ohio and Florida, politically divided states that are likely to be crucial to the outcome of the November 6 election.

So is Clinton’s re-emergence in presidential politics pave the way for his wife, Secretary of State Hillary Rodham Clinton, to get back in the game and run for president in 2016, eight years after losing the Democratic nomination to Obama?

It’s safe to say that a good number of loyal Democrats in Charlotte this week hope so. Former U.S. House of Representatives speaker Nancy Pelosi is publicly rooting for Hillary Clinton to run again.

Mrs. Clinton will be 69 on Election Day in 2016 – the same age that Republican Ronald Reagan was when he took office in 1981. She is retiring from the State Department post after the November election.

But whether Obama – the nation’s first African-American president – wins or loses in November, the former first lady will hear calls from Democrats to help her party make history again.

(Editing by Doina Chiacu)