WASHINGTON — After an election focused heavily on the economy and the soaring national debt, Washington will immediately turn to a year-end debate that has the potential to dramatically affect both: the looming "fiscal cliff."
Unless Congress acts by New Year's Eve, taxes will rise for nearly 90 percent of Americans on Jan. 2, and the White House will be forced to carry out nearly $100 billion in automatic cuts to the Pentagon and other agency budgets.
With neither party on track to take complete control of the White House, Senate and House, the fiscal cliff will require a compromise that has for the past two years eluded President Barack Obama and House Republican leaders. Failure to achieve consensus has the potential to throw the nation back into recession as households absorb a hit to their finances averaging $3,500.
"When we wake up Wednesday morning, the fiscal-cliff clocks will start," said Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. "Hopefully, the fiscal cliff will be the excuse for the parties to start working together. Hopefully, it will provide the excuse and cover for both sides to come to the table."
During the campaign, Obama and Republican challenger Mitt Romney vowed to take very different approaches to the year-end convergence of expiring tax breaks and spending cuts.
As the campaign wound down, it became clear that Obama's reelection would set the stage for an epic battle over taxes and spending with potentially far-reaching consequences. Democrats said a freshly reelected Obama would draw a line in the sand over his demand for increasing tax rates for the wealthy. He would invite Republicans to acquiesce to this demand or risk taking the blame for a dangerous political gridlock, as they did during the 2011 battle over the federal debt limit.
"Republicans face a choice, and the choice is theirs," said Rep. Chris Van Hollen, Md., the senior Democrat on the House Budget Committee. "If they want to drive off the fiscal cliff, that means they want to go into January demanding that people like Mitt Romney get a bonus tax break or nobody gets any tax relief."
It was not clear how Republicans would respond. Late Tuesday, House Speaker John Boehner, R-Ohio, was expected to repeat his insistence that Republicans stand firm against any increase in taxes, especially for taxpayers who earn more than $250,000. That category includes many business owners.
Democrats said an Obama victory would give him a mandate on the tax issue because the promise to raise taxes on the wealthy was a centerpiece of his campaign. Some senior Republicans agree. For months, Republican tax aides have been at work on ideas for a potential compromise that would keep the top tax rate at 35 percent, as Republicans prefer, while enacting new provisions to extract about $55 billion next year from households earning more than $250,000 a year, meeting Obama's goal to raise taxes on top earners.
Republicans said such a deal, if possible, would hinge on Obama's willingness to rein in the cost of federal entitlement programs, including Social Security and Medicare, the biggest drivers of future borrowing. Obama's most recent budget request proposed only modest trims to federal health-care programs, totaling about $360 billion, and no changes to Social Security.
Obama went further in 2011 budget negotiations with Boehner, offering to raise the eligibility age for Medicare from 65 to 67 and to apply a less-generous measure of inflation to Social Security benefits. However, liberal Democrats are opposed to those changes and others that reduce retirement benefits, while it is not clear that Republicans who have been demanding more fundamental restructuring of Medicare would view even those changes as a sufficient reason to raise taxes.
Absent a compromise on taxes, many Democrats, notably Sen. Patty Murray, Wash., have said they would be willing to let the tax breaks expire and challenge Republicans to reject new legislation to cut rates for 98 percent of Americans. But going over the cliff has the potential for chaos, disrupting the 2012 tax filing season and exposing Democrats to criticism that they were willing to jeopardize the economy for political gain.
During the campaign, Romney said that if elected he would seek a year-long extension of current tax policy, including low rates adopted during the George W. Bush administration, to give his administration time to develop a plan to overhaul the tax code.
Obama has vowed to veto legislation that extends the Bush tax breaks for the wealthy, but administration officials declined to say whether that threat would stand in the face of a Romney victory. Politically, it would be a risky move for Democrats to tell Romney that he cannot have a year to negotiate a budget deal — especially headed into the 2014 election, when 20 Democrats from moderate to conservative states are up for reelection.
Extending those policies is likely to avert a recession, but it would put the nation on track for a fifth straight year of budget deficits hovering in the range of $1 trillion and invite another downgrade of the nation's credit rating. In this scenario, Romney would be forced to act quickly on a broader deficit-reduction plan.
"We'll be on our way to doing tax reform and entitlement reform and an overall budget deal in 2013. And it's got to be done by the August recess," said Ken Kies, a top Republican tax lobbyist. "For a new president, the magic window of opportunity doesn't stay open forever."
During the campaign, Romney pledged to balance the budget within eight years by dramatically slashing most government spending, including Medicaid and other safety-net programs for the poor. He also pledged to increase military budgets and to overhaul the tax code without raising additional revenue.
Instead, Romney's tax plan calls for a 20 percent reduction in rates for all taxpayers, financed by the elimination of tax breaks primarily for the wealthy — a proposal that independent budget analysts have called mathematically impossible. Romney has nonetheless insisted that his tax plan is essential to reviving the economy and creating jobs, the central mission of his first term.