On edge of 'cliff', some see chance to end debt paralysis

Two years ago this month, the leaders of a presidential commission rolled out a startling plan to dig the nation out of debt. After decades of profligacy, they said, Washington must tell people to work longer, pay higher taxes and expect less in retirement.

Lawmakers recoiled from the blunt prescriptions of Democrat Erskine Bowles and Republican Alan Simpson. But their plan has since been heralded by both parties as a model of clear-eyed sacrifice, and policymakers say the moment has come to live up to its promise.

When Congress returns to Washington on Tuesday, the most urgent task facing President Barack Obama and congressional leaders will be avoiding the year-end "fiscal cliff," a towering accumulation of $500 billion in budget cuts and expiring tax breaks that would abruptly reduce government borrowing but could trigger a new recession.

In the past, policymakers have handled such moments by delaying the pain and giving themselves new deadlines for getting the budget under control. Now, however, the national debt is larger, as a percentage of the economy, than at any time in U.S. history except for the period after World War II — and it's rising rapidly. Avoiding hard decisions could have grave consequences, analysts say, potentially undermining the U.S. economic recovery and the world's confidence in American leadership.

"I think this is the magic moment," said Bowles, a veteran negotiator who served as chief of staff in the Clinton White House. "They've got to compromise. And I think if you listen carefully to what all the politicians are saying, there's room to get something done."

Few expect Washington to replicate the scope of the Bowles-Simpson plan. Though it is widely praised, its $4 trillion in 10-year savings includes major changes to Social Security opposed by liberals and an aggressive new tax code that would generate far more revenue than most conservatives could stomach.

Last week, House Speaker John Boehner, R-Ohio, publicly urged Obama to return to a less ambitious framework drafted in secret during the summer of 2011, when the two men came tantalizingly close to compromise. That blueprint would save about $2 trillion, on top of $1.3 trillion in agency cuts already in force.

About half the new savings would come from reversing part of the massive tax cuts that, along with the collapse of tax collections during the recent recession, are a major cause of current budget problems. The rest would come from lower spending, including on Social Security and Medicare, forecast to be the biggest drivers of future borrowing.

The 2011 talks collapsed when Obama asked for more revenue and Boehner, facing a conservative insurrection over taxes, abruptly called the deal off. The obstacles are similar now: Republicans are still talking vaguely about raising money through economic growth rather than higher taxes, and key Democrats are arguing that Obama's reelection victory entitles them to resist cuts to retirement benefits while demanding even more in new taxes.

Still, as they prepare to launch a fresh round of talks Friday at the White House, Boehner and Obama both have delivered nuanced public statements that seem to leave the door open to the historic "grand bargain" both men are said to desire.

Boehner's offer last week to raise revenue through tax reform "was a positive sign," Obama senior campaign adviser David Axelrod said Sunday on CBS's "Face the Nation."

While Obama is demanding higher taxes on the wealthy and Boehner is resisting an increase in the top tax rate, Axelrod said, "obviously, there's money to be gained by closing some of these loopholes and applying them to deficit reduction. So I think there are a lot of ways to skin this cat so long as everybody comes with a positive, constructive attitude toward the task."

Lawmakers streaming into town for the first time since September are nervously expectant. For two years, the debate over the debt has paralyzed the Capitol. Now policymakers face a particularly brutal decision point.

The fiscal cliff amounts to the largest one-year dose of government austerity since 1968, when Congress raised taxes and was blamed for triggering a recession. Without preventive action, the United States will go on a debt-fighting diet comparable to those recently undertaken in Spain, Italy and the United Kingdom. Simply delaying the pain is not an option, economists say.

"We would be stepping into an economic netherworld of slow growth and high unemployment that would leave us very vulnerable to anything else that goes wrong," said Mark Zandi, chief economist at Moody's Analytics. "The window is as far open as it's ever going to be. It's the president's second term. He's got to go through it."

The cliff was not constructed intentionally, but it was no accident, either. For decades, Washington has been postponing tough decisions about taxes and spending. The result: dozens of temporary provisions that are forever expiring. This year, they all happen to come due Dec. 31.

Take the Medicare sustainable growth rate, or SGR. Enacted as part of the 1997 Balanced Budget Act, the SGR was designed to make sure payments to providers grew no faster than the overall economy. But doctors screamed when the formula required cuts in 2002, and Congress has since passed legislation, known as the "doc fix," to temporarily override the SGR.

Because Congress has not changed the underlying formula, the payment cut gets bigger and the doc fix gets more expensive with each passing year. In January, Medicare providers face a payment cut of 27 percent unless lawmakers come up with $18 billion to override the formula for another year.

The cliff is packed with such quandaries. On the tax side, most date to the start of the George W. Bush administration, when the budget was in surplus and the nation was paying down its debt for the first time in a generation. Bush took office on a promise to return the surplus to the taxpayers.

The Bush tax cuts were so big and far-reaching their effects rippled through the code. Suddenly, millions of people's tax bills were so low they were in danger of being forced into an expensive parallel system known as the alternative minimum tax, or AMT. So that had to be patched, too.

The latest AMT patch expired last December, and unless Congress acts, 26 million people will have an extra $3,700, on average, tacked onto their 2012 tax bills. The cost of patching the AMT for 2012: $92 billion.

The Bush tax cuts are also temporary. To avoid increasing deficits far into the future, lawmakers designed them to expire in 2010. Obama extended them for another two years, piling on a temporary payroll tax holiday to boost the sluggish recovery. That also expires in December.

All told, expiring tax breaks account for nearly four-fifths of the $500 billion the cliff is projected to suck out of the economy between January and September. Automatic budget cuts, known as the sequester, are almost an afterthought. According to the nonpartisan Congressional Budget Office, they amount to $65 billion in the fiscal year that ends in September, evenly split between the Pentagon and domestic programs.

Because Republicans have so far insisted on taming the debt through spending cuts rather than tax increases, the sequester was essential to winning GOP support for legislation to increase the nation's debt limit after the Obama-Boehner talks broke down in 2011. The threat of across-the-board cuts was supposed to force a special congressional "supercommittee" to come up with a more reasonable way to save money. But the supercommittee disbanded in failure last November.

Many Republicans say Obama's victory will serve to break the stalemate. With his post-election speech, Boehner essentially offered to reverse three decades of GOP orthodoxy on taxes.

"The movement on the part of the GOP to say that revenues are part of this mix is significant," said Rep. Peter Roskam, R-Ill., who as chief deputy whip will be responsible for rounding up votes. "Obama can take his victory lap on more revenue. Let's give the GOP a victory lap on keeping rates low and call it a win."

In return for their concession, however, Republicans say they will demand structural changes to retirement programs on the order of those Obama offered in 2011, including raising the eligibility age for Medicare from 65 to 67 and applying a stingier measure of inflation to Social Security.

Those ideas are "very constructive," said Sen. Patrick Toomey, R-Pa., an anti-tax conservative who served on the supercommittee. "The problem is big government programs are growing faster than the economy. It doesn't matter what you do on the tax side if you have spending consuming ever more of our economy with no end in sight."

Democrats oppose cutting benefits. But Senate Majority Leader Harry Reid, D-Nev., and House Minority Leader Nancy Pelosi, D-Calif., told Obama they would support the secret deal in 2011. If he leads them there now, they are likely to follow.

"We've been resisting the obvious for the past two years," said Rep. Peter Welch, D-Vt., a liberal who advocates compromise. "And the obvious is: There's no grand bargain that will not cause political pain for all of us."