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WASHINGTON (Reuters) - Hopes rose on Monday that Washington will be able to step back from the "fiscal cliff" as President Barack Obama and Republican John Boehner inched toward a deal that would prevent steep tax hikes and spending cuts that could push the economy into recession.
The two men held talks at the White House and aides from both parties said they were optimistic an agreement was shaping up.
Though Obama and Boehner appeared to be edging closer to an agreement, substantial hurdles remain. Rank-and-file Republicans could have trouble with the tax increases on the wealthiest Americans that are likely to be part of any deal, while Obama could have a tough time selling spending cuts to his fellow Democrats.
Democratic Representative Chris Van Hollen, a member of the House leadership from Maryland, said he saw a 50 percent chance of putting an accord in place before January, when $600 billion worth of across-the-board tax increases and spending hikes are due to begin kicking in.
"I still think there's quite a ways to go before the finish line," he said.
But investors were cheered by signs of progress and the Standard & Poor's 500 index of U.S. stocks rose 1.19 percent.
Economists warn that going over the fiscal cliff could push the economy into recession.
Senate Democratic leader Harry Reid said his chamber will wrap up work on the issue after Christmas.
"It appears that we're going to be coming back the day after Christmas to complete work on the fiscal cliff," he said on the Senate floor.
Boehner, the speaker of the Republican-controlled House of Representatives, faces a crucial test on Tuesday morning when he is expected to brief House Republicans. He is not expected to bring any deal up for a vote unless a majority of the House's 241 Republicans support it.
Republicans have campaigned for decades on a promise to keep taxes low, but Boehner in recent days has edged closer to Obama's demand to raise tax rates on top earners. In return, Obama could back a measure that would slow the rate of growth of Social Security retirement benefits by changing the way they are measured against inflation, according to a Senate Democratic aide.
In a step toward an agreement, Boehner has put forward a tax increase for those earning over $1 million annually, while Obama wants that threshold set at $250,000. Republicans could probably stomach a tax hike on incomes above $500,000, a Republican aide said.
Boehner's latest proposal calls for $1 trillion in new tax revenue, which would come from raising rates and limiting deductions that the wealthiest can take. That is $400 billion less than the White House wants, but the gap between the two sides has narrowed by half in recent weeks.
If there are no strong objections, he could try to finalize the deal with Obama on Wednesday, a Republican aide said.
Both sides declined to say what Boehner and Obama discussed at the meeting, which was also attended by Treasury Secretary Timothy Geithner.
The White House said Boehner's latest proposal doesn't meet its standards.
"Thus far the president's proposal is the only proposal that we have seen that achieves the balance that is so necessary," White House spokesman Jay Carney said at a news briefing.
Republicans understand that the clock is ticking and they are confident that Boehner will get a deal they can support in the coming days, a senior House Republican aide said.
Republicans want substantial spending cuts in return for increased tax revenue, but any proposal to trim popular benefit programs like the Medicare health insurance plan for seniors will face fierce resistance from liberal Democrats, whose votes will be needed to get a deal passed.
Obama could also face strong opposition from Democrats if he agrees to Boehner's proposal to slow the growth of Social Security benefits by changing the way the cost-of-living increases are measured against inflation, an approach that could save $200 billion over 10 years.
Obama also wants to head off another confrontation over the government's debt limit, which will need to be raised in the coming months. Republicans insist that any increase in the government's $16.4 trillion borrowing authority must be paired with an equal reduction in spending.
Additional reporting by Thomas Ferraro, Mark Felsenthal, Rachelle Younglai and Jeff Mason; Writing by Andy Sullivan; Editing by Alistair Bell and Eric Beech