The Democrats began the year demanding more domestic spending and tax hikes. President Obama talked about it in his State of the Union address. His budget reflect those positions. And in his attack on Rep. Paul Ryan (R-Wis.) he reiterated those goals. Now debt-ceiling talks are progressing, according to multiple sources, with very substantial cuts, Medicare reform and hard spending caps contemplated. Moreover, Democrats are now talking about a payroll tax cut. How’d we get from there to here?

There were five critical steps after the 2010 election. First, the Senate held its ground and rejected the omnibus spending bill. Second, in a temporary and then a final vote on the continuing resolution for the 2011 budget Democrats agreed to more cuts, breaking the backs of those arguing for more spending (“stimulus”). Third, House Speaker John Boehner (R-Ohio) set down a marker: Every dollar the debt ceiling is raised requires a dollar in cuts. Fourth, Sen. Mitch McConnell (R- Ky.) made clear again this week that there will be no tax hikes. Fifth, Republicans generally did not flinch when the Democrats went on their Medicare scare campaign.

So now the question is how much to cut and can we work in some tax cuts before Congress gets to overall tax reform. Remarkable, isn’t it?

Sources with knowledge of the debt-ceiling talks confirm several points. First, the talks do absolutely include Medicare reform. You can’t get serious cuts and real budget reduction without it (especially since GOP leaders have ruled out tax hikes). All that energy put into scaring seniors and vilifying Ryan may be for naught. Once Obama and the Democrats agree to cuts ( it’ll be “reforms” or “steps to strengthen”) in Medicare, that issue — sorry, lefty bloggers — would come off the table.

Second, the notion that there is some Gang of Six or Five or whatever that can push through tax hikes (as recommended by the debt commission) was once again shown to be a fantasy. In a tussle over the elimination of the ethanol tax credit (which would expire at the end of the year anyway), Sen. Tom Coburn (R-Okla.) at various points suggested Republicans were all on record for having voted to increase taxes (eliminate a tax credit). But with help from Sen. Jim DeMint and McConnell, that turns out to be untrue, as DeMint will be given a vote on his amendment to offset the elimination of the ethanol tax credit as well as to eliminate the ethanol mandate (which forces gas companies to use the stuff). The bottom line: Rather than establishing a “precedent” for tax hikes, the maneuvers confirmed that Republicans stand firmly in favor of no net tax hikes. Democrats have been told by every critical GOP voice (McConnell, Majority Leader Eric Cantor, Sen. Jon Kyl and the speaker) that there will be no tax hike. Period.

Third, there will come a time (unless the talks collapse) when conservatives in the House and Senate will have to decide if the great becomes the enemy of the perfect. The package won’t be as big as some want (which is always bigger than it is). It in all likelihood won’t include the balanced-budget amendment (Democrats oppose that in the same way Republicans oppose tax hikes), although there will be a bevy of real spending restraints. But it will be a giant step in the right direction, all the more impressive because Republicans control only the House.

That’s the optimistic version. Or, the talks could collapse, we could suffer a technical default and the markets could freak.