AMERICA ON THE PRECIPICE

TWENTY days out from a possible default on its loans by the world's richest nation, America's political leaders apparently agree that it should never have come to this. But on how best to put things right, they remain at loggerheads, deeply divided along ideological lines, anxiously protecting what Barack Obama has termed their "sacred cows" - for Republicans, low taxes for Democrats, coveted entitlement programs such as the national pension scheme and subsidised healthcare for seniors.

The US has racked up debts of more than $US14 trillion, roughly equal to its gross domestic product, and the trajectory portends fiscal disaster.

Without painful remedial action, the debt is expected to climb beyond $US20 trillion within five years, and hit $US25 trillion by 2021, just as the US is facing unprecedented challenges that threaten its global economic standing.

Even cutting a deal now will not avoid US debt rising for the foreseeable future as any new measures take time to bite.

But without action, warns US Treasury Secretary Timothy Geithner, "we face catastrophic damage to the American economy".

How has it come to this? At the beginning of the last decade, the non-aligned Congressional Budget Office was predicting annual budget surpluses of more than $US700 billion in the years 2009 to 2012. Instead, the US is notching deficits of more than $US1 trillion. In the current year, it's nearer $US1.5 trillion.

The US ledger has been skewed by several factors but, essentially, by costly wars in Iraq and Afghanistan funded mostly by borrowings, by stimulus measures to avert Depression 2.0 and by personal income tax cuts in 2001 and 2003 that have since denied the federal government billions of dollars in tax receipts.

Then, when the Great Recession took hold, Washington's tax take collapsed further while spending rose on government programs for the jobless and the poor, painting a deeper shade on a budget already awash with red ink. Simply servicing its debt is costing the US more than $US400 billion a year the fifth-biggest item in the federal budget.

Now, after months of political hysteria, the parties are hunkered in negotiations in search of a way forward. The impetus for a deal is the nation's looming default, which the Treasury says will likely occur on August 2.

That's because, under US law, the federal government is bound by a debt ceiling the maximum it can borrow via securities issued by the Treasury. The government's debt, nearing $US14.3 trillion, is already nudging that cap.

Without the ceiling being raised by Congress for the 13th time since 1995 Washington will not be able to meet its interest payments to individuals, corporations and foreign governments that hold US Treasury notes and bonds. Such an outcome would also disrupt government payments to retirees, the unemployed and other welfare recipients, as well as to US troops.

A default would be technical, rather than terminal. No one is suggesting the US is insolvent. In fact, in 1979, the government missed some payments for a couple of weeks, which did not precipitate mayhem.

But the dollar amounts then were trivial by comparison and a subsequent study by two academics concluded that the slip-up resulted in a sustained rise of more than half a percentage point in interest rates, costing taxpayers billions of dollars extra in interest payments.

The stakes now are infinitely higher. A default would threaten the country's treasured AAA credit rating, up-end financial markets and probably send the US economy crashing back into recession.

Yet negotiations over raising the debt ceiling drown in political rhetoric as Republicans and Democrats, and the Obama White House, lay claim to the moral high ground while playing to partisan political constituencies.

Republicans paint the Obama administration as profligate, even "socialist" Democrats point the finger at the president's predecessor, George W. Bush, whose two-term legacy was a national debt nudging $US10 trillion, double the amount he inherited.

Republicans insist that raising the debt ceiling be contingent upon deep cuts in government spending. Democrats want tax measures to be a part of any deficit-reduction plan. True to their constituency, Republicans reject tax hikes defending theirs, liberal Democrats say putting entitlement programs to the sword will hurt Americans who can least afford it.

Obama, meanwhile, recently upped the ante by calling for a plan to cut the deficit by $US4 trillion through a 3:1 split between spending cuts and revenue increases, putting him at odds with both sides of the political divide.

Obama wants a deal that creates room to finance USA Inc beyond next year's presidential election, while setting a decade-long course to a more sustainable budget.

"This is the United States of America, and we don't manage our affairs in three-month increments," he insisted yesterday.

But House Speaker John Boehner, a moderate Republican besieged by fiscal hardliners in his own party, acknowledges political reality and says that a deficit-reduction deal closer to $US2 trillion is achievable at best.

"Look, I have wanted all through this process to do what I would describe as the big deal that would fundamentally solve our spending problem and debt problem in the near to medium term," he says. "But at the end of the day, we've got to have a bill that we can pass through the House and the Senate. This is a Rubik's Cube that we haven't quite worked out yet."

FOR two centuries the US legislative system of checks and balances has been a plumb line of good government: a president, a bicameral Congress, each independent yet inter-dependent, each a counter-weight to the other.

Legislation is fashioned through a prism of competing ideas and interests, especially so when each chamber is controlled by opposite political parties, making the art of compromise essential for governing.

And yet, compromise can be elusive in an electoral cycle that passes judgment on members of the House of Representatives every two years. Cutting a bipartisan deal can be akin to threading the eye of a needle as elected representatives in any term first make good on their campaign promises and soon return to campaign mode as another election looms.

Deadlocked in negotiations, Democrats and Republicans see both opportunity and political risk ahead. A deficit-reduction deal hinges on a mix of tax reform and the reform of entitlements programs social security (pensions), Medicare (subsidised healthcare for the elderly) and Medicaid (care, similarly, for children, the poor and the disabled administered through the states).

Both parties defend their ideological patch by arguing that raising taxes (Republicans) or cutting spending too deeply (Democrats) would risk the economy's revival.

But the wealthiest Americans are paying the smallest percentage of their incomes in federal taxes in 50 years. Meanwhile, an ageing population is placing a growing burden on entitlements, the unfunded Medicare scheme in particular.

Obama advocates closing tax loopholes that have benefited the rich and corporations, and is set on ending the so-called Bush-era tax cuts for those earning more than $US250,000.

But his proposals hold no sway with the Republican caucus, many of whom proudly fly the flag of the Tea Party and champion its mantra of scorched earth economics.

Led by Minnesota Congresswoman Michele Bachmann, who is surging in Republican favour for the party's 2012 presidential nomination, the 87 newcomers elected last November are rejecting compromise. Bachmann says talk of catastrophe should the US default on its debt is a con and she will never vote to raise the debt ceiling.

Others echo her intransigence, including Sarah Palin, a latent presidential aspirant perhaps, who told Newsweek that refusing to lift the debt ceiling was "not the apocalypse". "The fact is that we have $US2.6 trillion in revenue coming in, and if we just use some common sense . . . we don't have to increase debt."

Spending cuts must be the priority, she urges. "We have to cut spending. It is imperative, and I will be very, very disappointed if Boehner and the leaders of the Republican Party cave on any kind of debt deal in the next couple of months."

It's an attitude that doesn't square entirely with her political hero, Ronald Reagan, who raised taxes in 1982 when necessary. And the head of the Office of Management and Budget at the outset of Reagan's administration, David Stockman, reckons it is time to reconsider the medicine.

He has previously put the case for a tax on Wall Street transactions.

"That's the first thing," he told CNN. "Second . . . we're going to need a consumption tax. And third, we're going to have to let the Bush tax cuts expire . . . Match that with the spending cuts, the entitlement reforms and the defence rollback, and you begin to put together a rational plan."

But on the left there is similar reticence. Liberal Democrats are rejecting calls for entitlement reform, with former speaker Nancy Pelosi, the Democrats leader in the House, declaring coolly: "We are not going to reduce the deficit or subsidise tax cuts for the rich on the backs of America's seniors and working families."

Even so, the entitlements issue cannot go forever unresolved.

SOCIAL Security the system into which Americans pay during their working lives in return for a guaranteed retirement benefit could be bolstered through a combination of lifting progressively the retirement age and means-testing recipients.

But Medicare presents, financially and electorally, a more complex challenge, with healthcare costs exploding and people living many years beyond retirement. Funded from general revenue, Medicare also is not means tested.

With opposition on both the left and right, any deal between the president and congressional leaders faces a difficult passage through Congress, although Boehner may be more at risk politically than the president: opinion polls suggest most Americans would blame the Republicans for failure and the economic fallout of a default.

Obama has sought to portray himself as the adult at the negotiating table, although critics ask why he was unable to push budget reform when Democrats controlled both houses of Congress.

By yesterday, his recent petulance, when he lambasted Republicans for protecting "millionaires and billionaires" at the expense of ordinary Americans, had moderated to a tone more paternalistic: "It's not going to get easier. It's going to get harder. So we might as well do it now pull off the Band-Aid eat our peas," he said of the parties. "If not now, when? If each side wants 100 per cent of what its ideological predispositions are, then we can't get anything done."

Obama says Americans feel a sense of urgency, but they appear caught betwixt and between. Opinion polls suggest they agree with deficit reduction, and say the emphasis should be on spending cuts not tax increases. But in some polls, seven out of 10 cite entitlement programs as sacrosanct, and not to be touched.

DEBT AND TAXES HOW THE KEY PLAYERS LINE UP

THE DEMOCRATS

PRESIDENT

BARACK OBAMA

Favours a major deal to solve the debt problem with spending cuts and tax increases for the wealthy, but opposes cuts that will change Medicare or Social Security. Appears willing to fight liberals in his own party, but must balance his desire for a big policy win with the need to keep his party united.

SENATE MAJORITY LEADER HARRY REID

Is apparently wary of a big-bang deal, but could back spending cuts and somewhat smaller tax increases for the rich. Has grown critical of Republicans walking away from deals and kept the Senate working through the July 4 holiday to pressure senators into making a deal.

HOUSE MINORITY LEADER NANCY PELOSI

Speaking on behalf of liberals in the House, Pelosi has warned Obama against any deal that leads to cuts in Social Security and Medicare. Hints she is prepared to lead a revolt of progressives against any deal that cuts middle-class entitlements without tax increases on the rich.

The Republicans

HOUSE SPEAKER

JOHN BOEHNER

Seemed willing to cut a major debt reduction deal with Obama, with spending cuts far outstripping tax increases, but pressures on his right flank forced him to abandon those negotiations. He lives in fear of overthrow by his ambitious deputy, Eric Cantor, who has a growing cadre of right-wing supporters.

HOUSE MAJORITY LEADER ERIC CANTOR

Leader of the hard-charging Tea Party radicals, Cantor has ruled out any deal that includes tax increases that are not offset by tax cuts elsewhere. His frosty relationship with Boehner is the source of speculation. "If there's a popularity contest right now, Cantor wins it," one party aide said.

PAUL RYAN

The rising Republican star from Wisconsin has drafted an ambitious blueprint that massively scales back the welfare state and cuts taxes for the wealthy, making him a favourite of the Tea Party. But the proposals have fallen flat with the public at large.