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What's at stake if the US falls over the 'fiscal cliff'

So long as legislators and the president appear to be working towards agreement, the tax hikes and spending cuts could mostly be held at bay for a few weeks.

WASHINGTON // Efforts to save the US from going over a year-end "fiscal cliff" were still in disarray as lawmakers returned to the Washington to confront the tax-and-spend crisis. A tone-setting quotation was the Democratic senator Harry Reid's assertion that the House of Representatives under the Republican speaker John Boehner had been "operating with a dictatorship".

The US president, Barack Obama, flew back to Washington from Hawaii after telephoning congressional leaders from his Christmas holiday perch. Once back, he set up a meeting with leaders of both parties at the White House late Friday to make a fresh attempt to find a solution.

Here's a look at why it's so hard for Republicans and Democrats to compromise on urgent matters of taxes and spending, and what happens if they fail to meet their deadline:

New Year's headache

Partly by fate, partly by design, some scary fiscal forces come together at the start of 2013 unless Congress and Mr Obama act to stop them. They include:

> Some US$536 billion (Dh1.9bn) in tax increases, touching nearly all Americans, because various federal tax cuts and breaks expire at year's end.

> About $110bn in spending cuts divided equally between the military and most other federal departments. That's about 8 per cent of their annual budgets, 9 per cent for the Pentagon.

Hitting the national economy with that double whammy of tax increases and spending cuts is what's called going over the "fiscal cliff." If allowed to unfold over 2013, it would lead to recession, a big jump in unemployment and financial market turmoil, economists predict.

What if they miss the deadline?

If there is not a deal by today arrives without a deal, the nation shouldn't plunge onto the shoals of recession immediately. There still might be time to engineer a soft landing.

So long as legislators and the president appear to be working towards agreement, the tax hikes and spending cuts could mostly be held at bay for a few weeks. Then they could be repealed retroactively once a deal was reached.

The big wild card is the stock market and the nation's financial confidence: would traders start to panic if Washington appeared unable to reach accord? Would worried consumers and businesses sharply reduce their spending? In what could be a preview, stock prices in the US and Europe dropped Friday on waning hopes that Mr Obama and key lawmakers would reach an 11th-hour compromise.

Federal reserve chairman Ben Bernanke has warned lawmakers that the economy is already suffering from the uncertainty and they shouldn't risk making it worse by blowing past their deadline.

What if they never agree?

If negotiations between Mr Obama and Congress collapse completely, 2013 looks like a rocky year.

Taxes would jump $2,400 on average for families with incomes of $50,000 to $75,000, according to a study by the non-partisan Tax Policy Centre. Because consumers would get less of their paychecks to spend, businesses and jobs would suffer.

At the same time, Americans would feel cuts in government services; some federal workers would be furloughed or laid off and companies would lose government business. The nation would lose up to 3.4 million jobs, the Congressional Budget Office predicts.

"The consequences of that would be felt by everybody," Mr Bernanke says.

The taxes

Much of the disagreement surrounds the George W Bush-era income tax cuts, and whether those rates should be allowed to rise for the nation's wealthiest taxpayers. Both political parties say they want to protect the middle class from tax increases.

Several tax breaks begun in 2009 to stimulate the economy by aiding low- and middle-income families are also set to expire today. The alternative minimum tax would expand to catch 28 million more taxpayers, with an average increase of $3,700 a year. Taxes on investments would rise, too. More deaths would be covered by the federal estate tax, and the rate climbs from 35 per cent to 55 per cent. Some corporate tax breaks would end.

The temporary Social Security payroll tax cut also is due to expire. That tax break for most Americans seems likely to end even if a fiscal cliff deal is reached, now that Mr Obama has backed down from his call to prolong it as an economic stimulus.

The spending

If the nation goes over the fiscal cliff, budget cuts of 8 per cent or 9 per cent would hit most of the federal government, touching all sorts of things from agriculture to law enforcement and the military to weather forecasting. A few areas, such as Social Security benefits, Veterans Affairs and some programs for the poor, are exempt.

There's more at stake

All sorts of stuff could get wrapped up in the fiscal cliff deal-making. A sampling:

> Some 2 million jobless Americans may lose their federal unemployment aid. Mr Obama wants to continue the benefits extension as part of the deal; Republicans say it's too costly.

> Social Security recipients might see their checks grow more slowly. As part of a possible deal, Mr Obama and Republican leaders want to change the way cost-of-living adjustments are calculated, which would mean smaller checks over the years for retirees who get Social Security, veterans' benefits or government pensions.

> The price of milk could double. If Congress doesn't provide a fix for expiring dairy price supports before January 1, milk-drinking families could feel the pinch. One scenario is to attach a farm bill extension to the fiscal cliff legislation - if a compromise is reached in time.

> Millions of taxpayers who want to file their 2012 returns before mid-March will be held up while they wait to see if Congress comes through with a deal to stop the alternative minimum tax from hitting more people.

Call the whole thing off?

In theory, Congress and Mr Obama could just say no to the fiscal cliff, by extending all the tax cuts and overturning the automatic spending reductions in current law. But both Republicans and Democrats agree it's time to take steps to put the nation on a path away from a future of crippling debt.

Indeed, the automatic spending cuts set for January were created as a last-ditch effort to force Congress to deal with the debt problem.

If Washington bypassed the fiscal cliff, the next crisis would be just around the corner, in late February or early March, when the government reaches a $16.4 trillion ceiling on the amount of money it can borrow.

Mr Boehner says Republicans won't go along with raising the limit on government borrowing unless the increase is matched by spending cuts to help attack the long-term debt problem. Failing to raise the debt ceiling could lead to a first-ever US default that would roil the financial markets and shake worldwide confidence in the United States.

To avoid that scenario, Mr Obama and Mr Boehner are trying to wrap a debt limit agreement into the fiscal cliff negotiations.

So what's the holdup?

They're at loggerheads over some big questions.

Mr Obama says any deal must include higher taxes for the wealthiest Americans. Many House Republicans oppose raising anyone's tax rates. Mr Boehner tried to get the House to vote for higher taxes only on incomes above $1 million but dropped the effort when it became clear he didn't have the votes.

Republicans also insist on deeper spending cuts than Democrats want to make. And they want to bring the nation's long-term debt under control by significantly curtailing the growth of Medicare, Medicaid and Social Security - changes that many Democrats oppose.

Mr Obama, meanwhile, wants more temporary economic "stimulus" spending to help speed up a sluggish recovery. Republicans say the nation can't afford it.

It's not just Washington

Seems like they could just make nice, shake hands and split their differences, right?

But there's a reason neither side wants to give ground. The two parties represent a divided and inconsistent America. True, Mr Obama just won re-election. But voters also chose a Republican majority in the House.

Republicans and Democrats alike say they are doing what the voters back home want.

Neither side has a clear advantage in public opinion. In an Associated Press-GfK poll, 43 per cent said they trust the Democrats more to manage the federal budget deficit and 40 per cent preferred the Republicans. There's a similar split on who's more trusted with taxes.

About half of Americans support higher taxes for the wealthy, the poll says, and about 10 per cent want tax increases all around. Still, almost half say cutting government services, not raising taxes, should be the main focus of lawmakers as they try to balance the budget.

When asked about specific budget cuts being discussed in Washington, few Americans express support for them.

The current Congress is in session only until Wednesday. After that, a newly elected Congress with 13 new senators and 82 new House members would inherit the problem.

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