When they return to Washington after the election, lawmakers will have less than two months before the so-called fiscal cliff, or the $607 billion in tax increases and spending cuts set to take effect in January. If Congress doesn't act, the Bush-era tax cuts will expire, a 2 percentage-point cut in the payroll tax will lapse and automatic cuts in defense and domestic programs will take effect. The top tax rate on ordinary income would rise to 39.6 percent from 35 percent.

Inaction probably would cause a recession in the first half of 2013, according to the Congressional Budget Office. Economists from The Goldman Sachs Group Inc. wrote in a note yesterday that most of the negative effects would come from policies, such as expiration of middle-class tax cuts, which both parties want to avoid and that are embedded within more contentious issues.

The lame-duck Congress — including members who will leave office in January — will have a compressed time frame. Lawmakers' willingness to act will be shaped by whether they think they will have a stronger negotiating hand if they wait until 2013. For example, a Republican sweep could mean little action while Congress waits for Mitt Romney to take office as president and sign an extension of the tax cuts and other Republican-favored policies.

Seeking Agreement

No pre-election negotiations are taking place between leaders in Congress and committee chairmen. Separately, a bipartisan group of senators including Mark Warner of Virginia and Saxby Chambliss of Georgia has been trying to come up with an agreement.

On the Democratic side, staff members are preparing questions that lawmakers will have to consider during the session, said a Senate Democratic aide who requested anonymity because the discussions are private. They won't volunteer cuts in entitlement programs such as Medicare, the aide said.

Another Senate Democratic aide said while Democrats are favorable about their electoral chances and aren't planning sacrifices, they are developing plans for a variety of scenarios. The realistic thing to do, said the aide who didn't want to be identified to discuss private conversations, is not to exclude possibilities.

Publicly, the parties are far apart, with Republicans maintaining they'll resist tax increases and defense cuts to avoid hurting the economy. Democrats say taxes must be increased for high earners. The administration says Obama will veto any bill that extends the tax cuts for high-income taxpayers.

Both parties say they think the other side can be pressured into compromising. Republicans have been pointing to Obama's 2010 decision to extend the tax cuts for all income levels and say he will relent on his veto threat. Democrats say they have leverage on raising taxes from high earners.

'Grand Bargain'

"The lure for Republicans to come to the table around a grand bargain should be the potential for serious entitlement reform, not the promise of a lower top rate in tax reform," Senator Charles Schumer, a New York Democrat, said in a speech last week.

Behind the scenes, the aides said, congressional offices are preparing for scenarios in which they don't have complete control and might work with the other side on a significant deficit-reduction package.

Such a deal, if it came together, would include overhauling entitlement programs and the tax code, along with up-front deficit reduction from taxes and spending as a kind of down payment. Congress could reach a more limited deal that would address only the most urgent issues for a short time. Foster said he expects the end-of-year negotiations to settle around the least common denominator of what the parties can accept.

Reaching a broader bipartisan agreement to avert the cliff and implement long-run deficit reduction will be difficult both policy-wise and politically. Obama's fiscal commission in 2010 couldn't get the supermajority required to advance its plan to Congress. Obama and House Speaker John Boehner couldn't reach a deficit reduction deal in 2011. The congressional deficit-reduction supercommittee in 2011 deadlocked.

The issues in play are ones that lawmakers have examined before, said Arshi Siddiqui, a former tax policy adviser to Representative Nancy Pelosi, the House Democratic leader.

"You get the right people in the room with a will to get to a deal, then it's not a difficult endeavor," she said.

The Republican aides said they are considering revenue options that would be the most palatable to Republicans, who oppose tax increases. The party places a priority on the top rate because that's what defines marginal economic incentives for taxpayers and businesses that pay taxes under the individual code.

Such a proposal would mean that Republicans would be using some of the potential revenue — and perhaps the most politically achievable revenue — from broadening the tax base to pay for preserving current rates. Under their preferred policy, they would broaden the tax base to pay for lower rates.

'Worth Exploring'

The idea is "something that's worth exploring," said Siddiqui, now a partner at Akin, Gump, Strauss, Hauer & Feld LLP in Washington. "From a Democratic perspective, it will be very much making sure that the middle class doesn't bear a disproportionate share of anything."

Possible options could include limits on deductions similar to those floated by Romney or the ones proposed by Obama. The 1986 tax overhaul included a "bubble rate" on high earners that clawed back some of the benefits they received from having some income taxed in lower brackets.

Coming up with options, particularly in a politically palatable way, remains tough, Foster said.

"Where is that unknown revenue source that's not higher rates that would satisfy the president that says he only wants higher rates?" he said.

Bloomberg News

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