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Some in Congress look to $55 billion fiscal cliff 'fallback'

By Richard Cowan

WASHINGTON (Reuters) - An idea percolating in the Congress, aimed at helping avoid the "fiscal cliff," would scrap the steep across-the-board spending cuts of $109 billion set to start on January 2 and replace them with more targeted savings of about $55 billion, according to aides familiar with the discussions.

Further measures to reduce the deficit would be considered later in 2013 under this approach.

An interim solution like this potentially could contain some revenue increases coupled with spending cuts, according to congressional aides. It also could provide some comfort to corporations, particularly in the defense industry, which are already panicky about the impact of lost government business.

But it would not resolve a more challenging element of the cliff: what to do about a broad range of income tax breaks enacted in 2001 and 2003 during the George W. Bush administration, valued at about $400 billion, that are scheduled to expire on December 31.

After much brinkmanship between Republicans and Democrats, the automatic spending cuts were mandated by Congress as part of a deal to raise the debt ceiling for federal borrowing last year. At the time, the assumption was that they would be replaced in a more deliberative way by a super committee, which failed.

Republicans and Democrats alike oppose the approach of the large spending cuts, which are split evenly between military and non-military programs, in part because they land on almost every account in those two categories, depriving Congress of the ability to think through the choices.

The $55 billion in cost savings from January through June - which members of both political parties reportedly are eyeing - would be from programs selected by Congress, according to aides who asked not to be identified. They also could include the closing of some tax "loopholes" that give breaks to companies or the wealthy.

RECESSION POSSIBILITY

The automatic spending cuts coupled with significant tax increases in January could take an estimated $600 billion out of the U.S. economy and push it into recession, according to the non-partisan Congressional Budget Office's assessment of the so-called fiscal cliff.

The chances of a comprehensive legislative solution to the cliff problem before January 1 are considered slight and members of Congress have been looking for some temporary fix to buy time once a new Congress and a new or re-elected president are sworn-in in January.

This effort is still in early planning stages but if it is approved, it likely would be coupled with a promise by Congress to work on more ambitious deficit-cutting tax and spending measures next year.

A "grand bargain" deal could see as much as $4 trillion in government savings over 10 years.

"It is a fallback with a decent chance of happening," a Senate Democratic aide said of a six-month, $55-billion plan. The aide emphasized that this was being batted around on the staff level and has not been publicly embraced by members of Congress.

A House Republican aide, who said a bipartisan group of senators have been mulling this initiative, was dismissive. "It doesn't make a lot of sense to replace half the cuts in the sequester and not the other half."

A few weeks ago, Senate Republican leader Mitch McConnell warned that any replacement for the "sequester" - the $109 billion in across-the-board spending cuts in 2013 and $1.2 trillion over 10 years - should not be any less ambitious in overall deficit reduction goals.

Efforts to replace $109 billion in spending cuts could grind to a halt, however, if Republican presidential candidate Mitt Romney wins election next month over President Barack Obama. That is because Romney, who would be sworn in on January 20, likely would ask Congress to give his incoming administration a couple months or so to propose its own deficit-reduction ideas.

But if Obama prevails in what is looking to be a close November 6 election, Congress will have a little more than one month during a post-election session to decide on a series of "fiscal cliff" budget and tax questions that have split lawmakers over the past two years.

TRACTION FOR TAX INCREASE?

The key to the success of an alternative deficit-reduction measure, the Senate Democratic aide said, was that there be "equal pain" for Democrats and Republicans in any replacement to the $109 billion in automatic spending cuts.

That would mean that Republicans agree to some military spending cuts and/or revenue increases along with reductions to domestic programs to get to the $55 billion figure.

But even some Democrats wonder whether a meaningful amount of revenue can be generated by a temporary six-month tax change.

Just as cutting spending is complicated in a deeply divided Congress, so is dealing with the role of taxes in any effort to reduce deficits that have exceeded $1 trillion in each of the past four years.

In the face of Obama's demands to keep income tax rates low for everyone except those earning more than $250,000 a year, Republicans insist that any rate increase will be a "non-starter" during Congress' "lame duck" session starting in mid-November.

One Senate Republican aide, who is familiar with some of the current fiscal cliff discussions in Congress, predicted an alternative Democratic idea for a temporary surtax on millionaires, for example, "is not going to go anywhere."

Meanwhile, plenty of Democrats and Republicans in Congress, as well as top Obama administration officials, have opposed renewing a 2 percent payroll tax cut that is set to expire on December 31. But earlier this month, former White House economic adviser Larry Summers urged its renewal as a way of further stimulating the economy. "Larry Summers still carries weight," said the Senate Democratic aide.

Another concept to cap the value of tax deductions that the rich can take is gaining traction in Congress, according to the Senate Republican aide. Romney has embraced this idea.

"Different numbers are being tossed around," the aide told Reuters, referring to a possible stop-gap revenue measure until Congress has time to weigh comprehensive tax reform.

ELECTORAL IMPACT

Without a doubt, any single formula for spending cuts or tax increases that congressional staffers hatch may live or die depending on the outcome of the November 6 elections.

Analysts are increasingly pointing to a status quo congressional election: one that keeps the House of Representatives under Republican control and the Senate under Democratic control.

Even as Obama and Romney battle for votes in the last two weeks of their campaigns, some Republicans on Capitol Hill are speculating about a victory by the Democratic president.

"If Obama wins, we're going to have to play the cards we're dealt and work out some negotiation with him," said one senior Republican aide who works on fiscal policy matters.

Another Republican aide added that if Obama "squeaks out" a victory, the president "will have a choice to make: He can pick a fight, make the lame duck toxic and we can go over the fiscal cliff, or we can work to find common ground on the framework for a bigger tax and entitlement reform agreement" that could take at least a year to put together.

At the same time, Democrats, who voice confidence in an Obama victory despite a late Romney surge, warn that they will stick to their demands that the wealthy share more of the burden of getting the U.S. fiscal house in order.

"We really think we're going to have leverage and we will use it," the Senate Democratic aide said, pointing to a contentious lame duck session that might be in need of a "fallback."

(Additional reporting by Kim Dixon; Editing by Fred Barbash and Bill Trott)

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