U.S. Senate leaders work to avoid New Year's 'fiscal cliff'

Sat Dec 29, 2012 1:51pm EST

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* Reid, McConnell and aides in last-ditch effort

* Some aides pessimistic deal can be reached in time

By Richard Cowan and Rachelle Younglai

WASHINGTON, Dec 29 (Reuters) - Congressional negotiators burrowed into their Capitol offices on Saturday to see if they can stop the U.S. economy from falling off of a "fiscal cliff" in just three days when the biggest tax increases ever to hit Americans in one shot are scheduled to begin.

Aides to Senate Majority Leader Harry Reid, a Democrat, and Senate Republican leader Mitch McConnell were expected to work through the day on a possible compromise that would set aside $600 billion in tax increases and across-the-board government spending cuts that are set to kick in next week.

A variety of lower taxes are scheduled to expire on Dec. 31. If allowed to rise, the approximately $500 billion value of the revenue increases would represent a historic hike when taken together.

The combined punch of the tax increases and spending cuts would likely put the U.S. economy into a downward spiral, according to economists' forecasts.

"We're now at the point where, in just a couple days, the law says that every American's tax rates are going up. Every American's paycheck will get a lot smaller. And that would be the wrong thing to do for our economy," President Barack Obama said in his weekly radio and Internet address, which was broadcast on Saturday.

At midday, McConnell walked into his office on the second floor of the Capitol. A sked by waiting journalists if he thought his efforts would be successful, McConnell responded: "I hope so."

A Senate Republican leadership aide said that it might not be known until sometime on Sunday whether these talks bear fruit. That is when leaders are expected to brief their rank-and-file members.

The Senate is scheduled to hold a rare Sunday session beginning at 1 p.m. EST (1800 GMT), but it was not clear whether the chamber would have fiscal cliff legislation to act upon.

Reid and McConnell and their staffs held last-ditch negotiations Friday night and resumed on Saturday with no guarantees that their efforts would pay off. Republicans remained opposed to Obama's demand that households making above $250,000 a y e ar see their income tax rate rise to 39.6 percent, from the current 35 percent, in order to help tame budget deficits.

In recent days, some aides have said that a $400,000 threshold, instead of $250,000, has been discussed as a possible compromise.

PESSIMISTIC OUTLOOK

Democrats and Republicans also are jousting over what to do about inheritance taxes on estates.

Unless Congress acts, the tax is set to jump on Jan. 1 to 55 percent with the first $1 million exempted for individuals. Currently, there is a 35 percent tax and a $5 million exemption.

One Democratic aide was pessimistic that McConnell would come up with a counteroffer that Reid would find acceptable. Such a counteroffer would have to be calibrated in a way that also could attract votes from conservative House Republicans, many of whom have balked at any tax rate increases.

Similarly, a senior House Republican aide on Saturday voiced pessimism about prospects for a deal.

"It's hard to see Reid agreeing to anything that can get the votes of the majority of the majority in the House, thereby allowing a bipartisan accomplishment," the aide said. A "majority of the majority" refers to the 241 Republicans who are in the 435-member House.

The Republican aide placed the blame squarely on Democrats, as many Republican members have done publicly, saying that going off the fiscal cliff is a "policy upside" for them. "Higher taxes, devastating defense cuts. The polls tell them they can win the PR war in January. From their perspective, why stop the cliff dive?"

Democrats, in turn, have publicly accused Republican House Speaker John Boehner of preferring to put off any tough fiscal cliff votes until after a Jan. 3 House election in which he is expected to win another two-year term as speaker.

If McConnell and Reid can manage to reach a deal on inheritance taxes and raising income tax rates on the wealthiest, they likely would throw into the compromise some other fiscal cliff solutions.

Those could include extending an array of other expiring tax breaks, such as one that encourages companies to conduct research and development. Also, Congress wants to prevent a steep pay-cut in January for doctors who treat elderly Medicare patients.

Lawmakers also want to prevent middle-class taxpayers from inadvertently creeping into a higher t ax bracket, known as the alternative minimum tax, intended for the wealthiest.

If the Reid-McConnell effort fails, Obama has asked the Senate to hold a vote on Monday on a "basic package" that would stop taxes from going up on the middle class and would extend long-term unemployment benefits that are about to expire. If it passed the Senate, its fate would be in the hands of the Republican-controlled House.

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