Fresh from reelection, president finds himself on edge of ‘fiscal cliff’

President Obama returns to Washington from the campaign trail Wednesday to face an epic year-end battle over taxes and spending that could ultimately tame the national debt and advance his ambitions for a second term.

The president, who won reelection late Tuesday, must now confront the “fiscal cliff,” nearly $500 billion in automatic tax hikes and spending cuts set to take effect in January that could throw the nation back into recession.

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If Obama can engineer a compromise to avert the cliff with the freshly reelected Republican House, he could set the stage for progress on other second-term priorities, including immigration reform, climate change and investments in education and manufacturing. Such a compromise could also infuse fresh energy into an economic recovery that has suffered from uncertainty over the future of federal budget policies.

“Getting a deal on long-term fiscal soundness is paramount to move forward and to see the economy really keep improving,” said Bill Daley, Obama’s former chief of staff. It will also “give confidence that the political system can address a major issue.”

With Congress scheduled to return to Washington next week for a post-election legislative session, policymakers will have just 49 days to reach consensus. At stake is the fate of dozens of expiring tax breaks — including lower rates for all taxpayers adopted during the George W. Bush administration — and deep cuts to the Pentagon and other agency budgets.

Obama has threatened to veto legislation to avert the cliff that extends the Bush tax rates for the wealthy. After a campaign focused heavily on that pledge, Democrats say the president is prepared to draw a firm line in the sand, even if it means letting one of the largest tax hikes in U.S. history take effect on Jan. 1.

“Republicans face a choice, and the choice is theirs,” said Rep. Chris Van Hollen (Md.), the senior Democrat on the House Budget Committee. “If they want to drive off the fiscal cliff, that means they want to go into January demanding that people like Mitt Romney get a bonus tax break or nobody gets any tax relief.”

Despite the risks to the economy — and the potential disruption to the 2012 tax filing season — Democrats see a clear advantage to going over the cliff. In January, once the Bush tax cuts have expired, Democrats would be free to draft their own plan to cut taxes for the middle class, but not the wealthy, and dare Republicans to reject it.

“If you allow all the tax rates to revert, you’re talking about raising $5 trillion over 10 years,” Van Hollen said. “So Republicans will have to choose: Do they prefer $5 trillion in [new] revenue? Or something in the range of $2 trillion?” The latter revenue figure is the target amount set by the independent fiscal commission led by Democrat Erskine Bowles and former GOP senator Alan K. Simpson of Wyoming.

Obama’s most recent budget request called for more than $1.5 trillion in new revenue over the next decade, primarily by raising rates and limiting the value of deductions on annual income over $250,000. In the coming days, Democrats say, Obama is likely to launch a concerted public relations campaign in support of his budget plan, continuing his call for a “balanced approach” to debt reduction.

Republicans have long resisted any increase in taxes, and conservatives say they will not bend, even if it means letting tax rates rise across the board.

“It’s a difficult position to be in,” acknowledged Rep. Jim Jordan (R-Ohio), chairman of the conservative Republican Study Committee. “But just two years ago, the American people sent 65 new Republicans to the House of Representatives. And they said, ‘Don’t go there and compromise with Barack Obama. Go there and stop him.’ ”

House Speaker John A. Boehner (R-Ohio) took a similar stand late Tuesday after voters returned a Republican majority in the House. By renewing the GOP majority, he said during an event in Washington, “the American people have . . . made clear that there is no mandate for raising tax rates.”

Still, faced with a determined Democratic president, many Republicans on Capitol Hill and elsewhere say the GOP will have few options but to compromise.

“I love what John Boehner is saying, but I have a hard time believing Republicans won’t cave,” said GOP tax lobbyist Kenneth J. Kies. To resist Obama, “you have to be prepared to shoot the hostages. You have to be prepared to let it all expire. And it takes a lot of courage to do that.”

For weeks, Republican tax aides have been mulling ideas for a potential deal that would keep the top tax rate at 35 percent, as Republicans prefer, while enacting new provisions to extract about $55 billion next year from households earning more than $250,000 a year, meeting Obama’s goal to raise taxes on top earners.

But any such deal, they say, would hinge on Obama’s willingness to rein in the cost of federal entitlement programs, including Social Security and Medicare, the biggest drivers of future borrowing. Obama’s most recent budget request proposed only modest trims to federal health-care programs, totaling about $360 billion, and no changes to Social Security.

Obama went further in 2011 budget negotiations with Boehner, offering to raise the eligibility age for Medicare from 65 to 67 and to apply a less-generous measure of inflation to Social Security benefits. It is not clear that Republicans — who have been demanding a fundamental restructuring of Medicare — would view Obama’s 2011 offer as sufficient inducement to raise taxes.

Meanwhile, many liberal Democrats are vehemently opposed to any reductions in retirement benefits, though others acknowledge that a trade will have to be made.

The question, said former White House economist Jared Bernstein, is what Democrats would be willing to give Republicans in return for prying them away from the influence of anti-tax activist Grover Norquist, who has maintained firm discipline among GOP lawmakers.

“I’m sure they’re going to ask for something big,” said Bernstein, now a senior fellow at the Center on Budget and Policy Priorities. “I think Republicans would value something on Social Security as a real trophy.”

Without a deal in December, policymakers would quickly face another economy-rattling deadline: The need to raise the federal debt limit, set at $16.4 trillion. Many Republicans insist that they will regain leverage in January and February as the Treasury Department runs out of options for managing the nation’s finances without additional borrowing authority.

But after the debt-limit battle of 2011, approval ratings for the GOP Congress went into free fall and many Republicans are not eager to repeat the experience.

“I get a sense there’s still a fairly strong interest in Congress among the conservatives to use the debt ceiling as some kind of leverage,” said Heritage Foundation senior fellow Patrick Louis Knudsen, who was a top aide on the House Budget Committee to Republican vice-presidential candidate Paul Ryan (Wis.). “But they are a bit chastened about how that worked — or didn’t work out — last year.”

 
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