By Kim Dixon and Richard Cowan
WASHINGTON (Reuters) - Members of Congress from both parties are increasingly mulling the unthinkable: going home in December without acting to avoid the $4 trillion in tax hikes and deep spending cuts known as the fiscal cliff.
Neither Democrats nor Republicans claim this is their preferred option, as it could rattle global financial markets badly and anger their constituents.
But as they circle each other in an ever-more partisan atmosphere they see little prospect for a settlement acceptable to both parties in the lame duck session of Congress after the November 6 election.
That is when they confront the wave of fiscal cliff decisions including how to handle expiration of temporary tax cuts that originated during the presidency of George W. Bush, $1.2 trillion in automatic spending cuts and the need to raise the debt ceiling again.
Some members and partisan strategists are concluding that they might be better off doing nothing.
They would come back in January with a new Congress relatively flush with cash - at least on paper - from the impact of the tax hikes; hit reset and start over to structure a new series of tax cuts. Call them the "Obama tax cuts" or "Romney tax cuts," depending on the victor in the November election.
The risk of shaking the markets is always there. But they could mitigate that by telegraphing to voters and Wall Street in advance that they definitely intend to write some new tax cuts into law. It could take a couple months, or maybe even all of 2013 and beyond, but they promise they will do it and they promise they will make the tax cuts retroactive to January 1, 2013.
"My preference would not be to accept a lesser solution than you could get in February and March just to say that you got it done before the end of the year," Senator Roy Blunt, a member of Republican leadership and congressional liaison to Republican presidential nominee Mitt Romney, told the 2012 Washington Reuters Summit last week.
Representative Chris Van Hollen of Maryland, a member of the Democratic leadership in the House of Representatives, said that if Republicans continue to demand a tax plan with breaks for the wealthy, Democrats should "take the question to the American people" in January by allowing historically low rates from the Bush years to expire.
"If they refuse, if the Republican position remains as it is today - which is, they are going to insist on holding tax relief for 99 percent of the American people hostage - I think we should just take that debate into next year," Van Hollen said.
A liberal Democratic think tank, the Center on Budget and Policy Priorities, has since argued that the cliff is more of a slope, and that any negative impact would be gradual. That may leave lawmakers some wiggle room.
Romney last month floated the idea of Congress leaving town and waiting until he arrives in late January to act, which initially brought gasps, in part because the Congressional Budget Office has said stepping off the "cliff" could push the U.S. economy into a recession in the first half of 2013.
"The prospects are substantial that the Bush tax cuts expire for at least a period of time," said a senior Senate Democratic aide. "This is not to say that folks plan that to happen, but a lot of folks will block other paths," the aide added.
The idea - while embryonic - is gaining traction. Peter Orszag, former head of the Obama administration's Office of Management and Budget, touted it as a strategy for a re-elected Obama in a widely discussed article in the summer issue of the journal "Democracy."
Obama would "escape the intractable debate" over the Bush tax cut extensions and come back in early 2013 with legislation that reduces taxes "disproportionately for middle- and low-income families," making it hard for Republicans to vote against them.
The reasoning goes like this.
Politicians are scared to death of raising taxes. But they wouldn't have to if they just let the Bush tax cuts expire. They don't have to lift a finger. They just let them die, as scheduled, on December 31.
Then, flush with cash, they take some of the $3.7 trillion, which they would then have on the budget books from the expired Bush tax cuts, and they announce to voters that they're going to give it back to them in the form of brand new tax cuts.
They take another chunk of the $3.7 trillion and devote it to deficit-reduction - maybe - and as they rewrite the tax code to include rate reductions for corporations and others, they also end some tax goodies, possibly getting more money for the Treasury.
Even though taxes for some might rise in the end, that bit of unpleasantness gets tucked into a tax-cut bill in a way that eases everyone's jitters. Politicians can brag about giving Americans new tax cuts. There's some new deficit-reduction - maybe and that might be a big maybe - as a result of Congress letting Treasury keep some of the Bush-era tax cuts that have died.
The approach reflects deep pessimism for an agreement to avoid the fiscal cliff other than some temporary fix, which, as Orszag noted, would only set the stage for more uncertainty and partisan struggle.
Political disagreements between Democrats and Republicans over whether the rich should continue to enjoy the benefits of the Bush tax cuts are at the center of the dispute that could end in deadlock on December 31.
But with just over a month between the election and the end of the year, not including holidays, the losing party will be sore and not apt to compromise.
Contributing to the ill will could be a court fight stemming from demands by the Republican-controlled House for documents about the Operation Fast and Furious gun-running scandal to Mexico that the administration refuses to provide. And, last week's Supreme Court decision to uphold the healthcare law also revived bitterness.
POSSIBLE SHORT-TERM DEAL
Among the other scenarios is a short-term extension of all the tax cuts, possibly attached to a trigger to force action on the deficit and tax reform. Many lawmakers are weary of that approach, though, since it failed so miserably last November in efforts to come up with a thoughtful $1.2 trillion in savings over 10 years to avoid the blunt axe of automatic spending cuts.
In a pre-election show vote, the Republican-controlled House of Representatives will pass a version of this in July, knowing it will hit a roadblock in the Democratic-controlled Senate.
During a nearly identical debate in 2010, Obama conceded to Republican demands to extend all the Bush-era cuts. In exchange, he got jobless benefits renewed and a payroll tax cut.
Back then, vulnerable Democratic senators fretted openly about the impact of raising taxes in a fledgling recovery. Some of these same senators are teetering again, with 20 Senate Democrats facing re-election in 2014.
"The problem with Obama's position on the Bush tax cuts is he doesn't even have majority support in the Senate on this," said Ethan Siegal, an investor adviser.
Democrats want to let low tax rates for the wealthiest expire - defined by some as those earning more than $250,000, while others favor the $1 million threshold.
Republicans want to extend the rates for all income groups.
DEBT CEILING WILD CARD
In any of these scenarios, everything is dependent on the outcome of the election.
If Obama wins, "I think somebody is going to pay 39.6 percent" in taxes, said Greg Valliere, an analyst for institutional investors.
Under the Democrats' proposal, the top tax rate for high earners would rise from 35 percent to 39.6 percent.
One wild card is the need to raise the limit on the Treasury Department's borrowing authority, known as the "debt ceiling." Republicans caused a stir last year when a group of Tea Party- allied conservatives advocated blocking any increase in Washington's borrowing authority without accompanying adequate budget cuts - even if that meant a historic U.S. default and government shutdown.
A deal eventually prevailed, but the deadlock was a factor in Standard and Poor's August downgrade of the U.S. credit rating for the first time in history.
House Democratic Leader Nancy Pelosi told the 2012 Reuters Washington Summit last week that Obama should avoid a rerun of that fight with Republicans by using his executive authority to raise the limit. It was an argument that some Obama confidants, including former President Bill Clinton, had unsuccessfully urged Obama to employ last year.
"I myself would not empower them (Republicans) to hurt the full faith and credit of the United States of America," Pelosi told Reuters.
(Reporting by Kim Dixon, Rachelle Younglai, Donna Smith, Richard Cowan, Thomas Ferraro and David Lawder. Editing by Fred Barbash and Jackie Frank)
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