Outraged U.S. lawmakers proposed a special surtax on Tuesday on millions of dollars in executive bonuses at bailed-out insurer American International Group Inc amid howls of protest over the payouts.

The AIG affair threatens to undermine the new Obama administration's multi-pronged effort to stabilize the financial system and pull the economy out of recession.

With one senator remarking that top AIG managers might even consider suicide, some lawmakers proposed slapping a surtax on the $165 million in bonuses for dozens of executives at a company that was once the world's largest insurer.

AIG, the recipient of a U.S. taxpayer bailout worth up to $180 billion, should be sued to get those bonuses back, said Barney Frank, the Democratic chairman of the powerful House of Representatives Financial Services Committee.

Taking a different approach, Democratic Representative Gary Peters introduced a bill to impose a 60 percent surtax on bonuses over $10,000 at any company in which the government has a 79 percent or greater equity stake. It now holds about 80 percent of AIG.

The surtax would be applied in addition to the top 35 percent income tax rate plus state and local taxes, making it possible to recover 100 percent of the bonuses, Peters said.

Currently, AIG is the only company that meets this threshold, he said in a statement. The legislation I'm proposing will get taxpayers their money back.

Similar bills were unveiled or threatened by lawmakers in both the House and Senate.

Republican Senator Charles Grassley said in a radio interview on Monday he would feel better if AIG's top managers were to take that deep bow and say 'I'm sorry' and then either do one of two things: resign or go commit suicide.

On Tuesday, he retreated from those remarks.

What I'm expressing here obviously is not that I want people to commit suicide, Grassley said. But I do feel very strongly that we have not had statements of apology.

OUTRAGE AND A WARNING

President Barack Obama, who took office eight weeks ago, expressed outrage on Monday about the bonuses, which come as the White House faces growing public skepticism about the huge bailouts going to major financial institutions -- none more so than AIG.

Obviously, the president is committed to working as quickly as possible with Congress to find ways to recoup this money, White House spokesman Robert Gibbs said on Tuesday.

Gibbs said that would include a range of ideas -- whether it's changing the tax code or whatever ideas are raised in Congress.

AIG, a giant that once stood astride the financial system, was due to pay bonuses by Sunday to employees of its financial products unit, which made bad bets on toxic mortgages and credit default swaps that brought the company to its knees.

Democratic Senator Charles Schumer warned AIG employees to give back the bonuses or face a major tax on the payments.

They should voluntarily return them. If they don't, we plan to tax virtually all of it, Schumer said.

Schumer, Senate Democratic leader Harry Reid and other Democrats expressed concern about the bonuses in a letter to AIG Chief Executive Edward Liddy, who is scheduled to testify on Wednesday to a House committee.

Lawrence Summers, a top White House economic adviser, said in an interview with CNBC television the Obama administration will be creative in dealing with the AIG bonuses.

The Treasury said on Monday it would modify a planned $30 billion infusion of government capital into AIG to try to recoup the bonuses.

As for the possibility of slapping a surtax on the bonuses, Senate Banking Committee Chairman Christopher Dodd said it was worth pursuing as an idea.

Democratic Representative Brad Sherman, a House Financial Services Committee member with Peters, said he favors a tax law to impose a substantial surtax on excessive compensation paid to executives at bailed-out firms, especially AIG.

New York Attorney General Andrew Cuomo said AIG created 73 millionaires with bonuses of $1 million or more. He has said he will subpoena AIG for more information about the bonuses, including the names of the recipients.

Representatives Bruce Braley and Joe Courtney, both Democrats, released a letter signed by 90 members of Congress to Treasury Secretary Timothy Geithner urging that planned bonuses to AIG executives be stopped.

Braley also said in a statement he introduced legislation to increase the tax rate on any bonuses awarded by businesses receiving government (bailout) funds, including AIG.

(Additional reporting by Kim Dixon, Richard Cowan, John Poirier, David Lawder, Thomas Ferraro, Susan Cornwell and Glenn Somerville in Washington and Jonathan Stempel in New York; Editing by John O'Callaghan)

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