The shape of a deal to avert the US fiscal cliff is at last emerging, with at least $1 trillion in new taxes, up to $1 trillion in fresh spending cuts and an increase in the debt ceiling, as negotiators scramble to reach agreement before the end-of-year deadline.

US president Barack Obama and John Boehner, Republican speaker of the House of Representatives, held their third face-to-face meeting in eight days at the White House amid signs of growing momentum in the talks.

Cloud of uncertainty

If they strike a deal in the coming days, and are able to pass it through Congress, it would remove a huge cloud of uncertainty hanging over the global economy.

Failure to avert the fiscal cliff – a combination of $600 billion in annual automatic tax hikes and spending reductions by the government starting next year – would probably tip the US into recession next year, a prospect that has alarmed global investors and the American public.

Signs that the two sides may be getting closer gave a positive mood to the US equity market, where the SP 500 was up 1 per cent in early trading.

Meanwhile US treasuries prices fell yesterday as greater optimism of a deal reduced demand for safe haven debt.

William Stone, chief investment strategist at PNC, told clients that politicians appeared committed to hammering out a deal.

“We believe there could be more progress this week than in previous weeks since Congress is scheduled to leave for the holidays at the end of this week. Importantly, if no progress is made, we expect policymakers to remain in Washington through the holidays.”

Senate majority leader Harry Reid, a Nevada Democrat, said yesterday it appears the chamber will need to reconvene on December 26th to work on the budget.

But reaching agreement will only be the first step. In particular, Mr Boehner may face challenges in passing the legislation if he is perceived by conservative members to have made too many concessions on taxes.

He is expected to discuss the talks with members of his party today. Some Democrats may also baulk at the terms of any deal if they believe Mr Obama compromised too aggressively on spending cuts.

A breakthrough came over the weekend, when Mr Boehner offered to allow tax rates to rise for millionaires from 35 to 39.6 per cent, abandoning his party’s long-held opposition to tax rate rises that Mr Obama has demanded.

Overall, Mr Boehner is offering a package worth nearly $1 trillion in new revenue – including about $500 billion to be achieved through a tax reform that would limit tax breaks and deductions next year.

While this is short of the $1.4 trillion in revenue Mr Obama is demanding, it leaves room for negotiations on final details.

Raising taxes

Among the options would be to raise tax rates for households earning more than $500,000 or $750,000 per year, which would bring in more revenue than Mr Boehner is allowing.

Mr Obama and Mr Boehner still have to settle on the nature of spending cuts, including to popular health and pension programmes, which Republicans view as essential to any package but many Democrats resist.

Mr Obama is reported to be considering a possible budget concession on social security cost-of-living increases.

Switching the inflation yardstick to the so-called chained consumer price index would reduce social security cost-of-living benefit increases and generate fresh revenue because it also would reset income tax brackets.

Some Democrats in Congress have said they are willing to make that change.

– Copyright 2012 The Financial Times Limited (Additional reporting: Bloomberg)