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With U.S. Vote Over, 'Fiscal Cliff' Ahead

Can Democrats and Republicans find a compromise on tax rises and spending cuts to avoid potentially sending the U.S. economy into recession?
Can Democrats and Republicans find a compromise on tax rises and spending cuts to avoid potentially sending the U.S. economy into recession?
If financial problems are comparable to falling off a cliff, the United States is standing on the edge of a dangerous new precipice.

At the end of this year, two events are scheduled to occur that aim to help reduce government debt but risk dramatically slowing the U.S. economy.

One is the expiration on December 31 of some tax cuts and the introduction of some tax increases. They would generate more revenue for the government to help balance the budget but mean less money in people's pockets for buying goods.

The other is the scheduled start of automatic cuts to the government's budget on January 1, 2013. They will help reduce government spending but, again, mean less money in the U.S. economy.

This conjunction of tax rises and budget cuts has been dubbed the "fiscal cliff." Getting over it safely is now one of reelected President Barack Obama's most urgent challenges.

The measures dubbed the fiscal cliff would extract some $600 billion from the U.S. economy, or 4 percent of gross domestic product, in 2013 alone, says Paul Dales, an economist at Capital Economics in London.

"So, in no uncertain terms, the U.S. economy would fall back into recession. It is thought that growth would be around 2 percent next year if the fiscal cliff were averted," Dales says. "But if the United States fell of the cliff, growth would probably be about a half percent."

That, in turn, would be a serious setback to the global economy. And the effects would not be confined to 2013. The tax changes would likely remain in place for years while the automatic deep spending cuts, known as sequestration, are set to reduce government spending by $109 billion every year for the next decade.

Battling Gridlock, Again

Just how seriously people view the fiscal cliff could be seen on November 7, when the U.S. stock market plunged more than 2 percent. Many observers attributed the drop partly to investor uncertainty over how well the second-term president will be able to get through the crisis amid a continuingly difficult political environment.

U.S. President Barack Obama (right) and House Speaker John Boehner need to find a compromise to steer clear of the "fiscal cliff."
U.S. President Barack Obama (right) and House Speaker John Boehner need to find a compromise to steer clear of the "fiscal cliff."
Any hope that the just-passed election could simplify things in Washington has now been tempered by the fact that on November 6 the Democrats retook the White House and Senate, while the Republicans retained control of the House of Representatives. That duplicates the often-gridlocked political situation of the past four years.

Party leaders on both sides vowed this week to work together following Obama's win. House Speaker John Boehner (Republican-Ohio) said lawmakers were "ready to be led, not as Democrats or Republicans but as Americans."

But he added, "In order to garner Republican support for new revenues the president must be willing to reduce spending on entitlement programs [eds.: social spending] that are the primary drivers of our debt."

Political differences are very much part of the fiscal-cliff problem because it is the two parties' conflicting views on how to reduce government debt that helped create it.

Republicans favor reducing government debt by cutting government spending but avoiding raising taxes. Democrats favor a combination of spending cuts and tax increases. The result often has been that compromise positions are hard to find.

Dangling Over The Cliff

Now the two sides must again engage in hard bargaining with little time to spare.

Under a compromise agreement struck in August 2011 to reduce government debt, the White House and Congress gave themselves until November 23 of this year to find a deficit-reduction package they both liked. As an incentive to negotiate, they agreed that if they could not reach an accord, deep, automatic spending cuts would start on January 1 -- the same sequestration that forms part of the fiscal cliff.

Now, as the fiscal cliff approaches, both sides are scrambling to find a way to avoid delivering such a shock to the economy.

One possibility is that the White House and Congress will reach enough small compromises on tax and spending provisions to reduce some of the government debt but not threaten the economic recovery.

Budget expert Isabel Sawhill of the Brookings Institution think tank in Washington described that option -- which analysts call "going partly over the cliff" -- during a conference on November 7.

"We reset the fiscal clock by going off the cliff, starting with higher revenues and lower spending and making some adjustments from there in the interest of keeping the economy from going further off the cliff and leading to a new recession," Sawhill said.

But whether U.S. leaders will ultimately agree on this or some other strategy remains anybody's guess.

RFE/RL Washington correspondent Richard Solash contributed to this report

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