Fiscal cliff: Impasse on tax rates is big hurdle

By ANDREW TAYLOR
Associated Press

WASHINGTON (AP) House Republicans' hard line against higher tax rates for upper-income earners leaves re-elected President Barack Obama with a tough, core decision: Does he pick a fight and risk falling off a "fiscal cliff" or does he rush to compromise and risk alienating liberal Democrats?

Or is there another way that will allow both sides to claim victory?

Obama has been silent since his victory speech early Wednesday morning, but is set to weigh in Friday in remarks at the White House.

Capitol Hill Republicans, meanwhile, vow to stand resolutely against any effort by the president to fulfill a campaign promise to raise the top two income tax rates to Clinton-era levels. A battle would set the tone for the start of the president's second term. "A 'balanced' approach isn't balanced if it means higher tax rates on the small businesses that are key to getting our economy moving again," House Speaker John Boehner, R-Ohio, said on Wednesday. "Raising tax rates is unacceptable," he declared Thursday on ABC. "Frankly, it couldn't even pass the House. I'm not sure it could pass the Senate."

A lot is at stake. A new Congressional Budget Office report on Thursday predicted that the economy would fall into recession if there is a protracted impasse in Washington and the government falls off the fiscal cliff for the entire year. Though most Capitol-watchers think that long deadlock is unlikely, the analysts say such a scenario would cause a spike in the jobless rate to 9.1 percent by next fall.

The analysis says that the cliff — a combination of automatic tax increases and spending cuts — would cut the deficit by $503 billion through next September, but that the fiscal austerity also would cause the economy to shrink by 0.5 percent next year and cost millions of jobs.

The new study estimates that the nation's gross domestic product would grow by 2.2 percent next year if all Bush-era tax rates were extended and would expand by almost 3 percent if Obama's 2 percentage point payroll tax cut and current jobless benefits for the long-term unemployed were extended as well. All sides say they want a deal — and that now that the election is over everyone can show more flexibility than in the heat of the campaign.

Obama will address the issue Friday though he's not expected to immediately offer specifics. His long-held position — repeatedly rejected by Republicans — is that tax rates on family income over $250,000 should jump back up to Clinton-era levels. Republicans say they're willing to consider new tax revenue but only through drafting a new tax code that lowers rates and eliminates some deductions and wasteful tax breaks. And they're insisting on cuts to Medicare, Medicaid and food stamps, known as entitlement programs in Washington-speak.

The White House's "opening position is, 'We're willing to do big entitlement cuts. In return we need you to go up on the rate,'" said Democratic lobbyist Steve Elmendorf. "Then they're going to get into a discussion. It'll be a process."

The current assumption is that any agreement would be a multi-step process that would begin this year with a down payment on the deficit and on action to stave off more than the tax increases and $109 billion in across-the-board cuts to the Pentagon budget and a variety of domestic programs next year. The initial round is likely to set binding targets on revenue levels and spending cuts, but the details would probably be enacted next year.

"What we can do is avert the cliff in a manner that serves as a down payment on — and a catalyst for — major solutions, enacted in 2013, that begin to solve the problem," Boehner said.

While some of that heavy work would be left for next year, a raft of tough decisions would have to be made in the next six weeks. They could include the overall amount of deficit savings and achieving agreement on how much would come from revenue increases and how much would be cut from costly health care programs, the Pentagon and the day-to-day operating budgets of domestic Cabinet agencies.

Democrats are sure to press for a guarantee that tax reform doesn't end up hurting middle-income taxpayers at the expense of upper-bracket earners. Republicans want to press for corporate tax reform and a guarantee that the top rate paid by individuals and small businesses goes down along the way.

While some Democratic partisans want Obama to play tough on taxes and use his leverage to force Republicans to accept higher rates on the wealthy, Republicans warn that such hardball would poison the well even before Obama takes the oath of office and imperil prospects for second-term Obama initiatives including immigration reform.

Another idea is to raise revenue from the wealthy but not through higher income tax rates. Instead, policymakers could cap the amount of itemized deductions that the wealthy might be able to claim, an idea that's in Obama's budget and was a suggestion of Mitt Romney in the campaign.

"There is more than one way to bell the cat. So why are people so fixed on the 39.6 (percent rate)? It's because of the progressivity of the code," said Sen. Kent Conrad, D-N.D., on CNBC on Thursday. "You can accomplish that same progressivity with lower rates if you broaden the (tax) base in a way that's progressive."

Other items on the agenda for the lame duck session include a multi-year farm bill, legislation to reform the Postal Service, and a renewal of Medicare payment rates for doctors.

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