The crux of U.S. budget battle: How to pay?

As Congress moves toward a massive end-of-year spending bill this week, both parties claim to be fighting on the side of fiscal responsibility.

Republicans are lining up with the White House in enforcing spending caps – a battle they are poised to win. Despite low public approval ratings, President Bush has enough votes in the Senate to block bills that he opposes, as long as most Republicans stand with him.

Meanwhile, Democrats are losing ground in their year-long bid to require that Congress pay for new tax cuts. A key test comes this week as the House and Senate work out their differences on a $50 billion "fix" to the Alternative Minimum Tax (AMT), which is now set to hit 22 million new taxpayers in the 2007 tax year. The House is requiring offsets; the Senate is not.

At issue is whether the atmosphere on Capitol Hill is now so partisan that Congress can't make the trade-offs needed to handle long-term fiscal challenges. By dealing with big-ticket items such as the AMT fix and the costs of the war, now about $10 billion a month, outside the normal budgeting process, Congress is shirking the hard choices needed to get America's fiscal house back in order, say budget watchdogs.

"Back when President Reagan was borrowing, government debt was $1 trillion. Now, we're borrowing on a credit card that's maxed out," says Stanley Collender, of Qorvis Communications, a business consulting firm.

The nation's fiscal situation is not unlike the plight of homeowners who signed on to adjustable rate mortgages and now risk losing their homes, Mr. Collender adds. "What we're going to find after George Bush leaves office is that the national debt will be financed with much higher interest rates."

In a new report released last week, the Congressional Budget Office (CBO) said that the federal budget is on an "unsustainable path." The reason: The government is spending more and more for healthcare programs and for interest payments on the federal debt, now topping $9 trillion.

In the past, the US funded its deficits by drawing on Social Security trust fund surpluses, but increasingly Washington is financing its debt by borrowing from abroad. "Over time, foreign investors would claim larger and larger shares of the nation's output, and fewer resources would be available for domestic consumption," CBO director Peter Orszag told the House Committee on the Budget Dec. 13.

The CBO estimates that the wars in Iraq and Afghanistan could cost $2.4 trillion over the next decade. Nearly $700 billion of that cost will be interest on the debt to finance the wars.

It's a cost that's largely invisible to the public now, but will be much more evident as interest rates increase. That's why it's important for Congress to take steps to address such issues now, say budget watchdog groups. Instead, they worry that Congress will abandon the principle of finding offsets for new taxes and spending, if it passes an AMT fix this week without offsets.

"It's going to be very difficult to build a sustainable fiscal future if you insist you can't have a rational discussion about all parts of the budget," says Robert Bixby, executive director of the Concord Coalition, who was on Capitol Hill last week to make a case for the pay-as-you-go principle. "Then, you're going over a cliff."

Since taking control of Congress in January, Democrats have aimed to win over GOP votes on issues ranging from taxes and spending to oversight of the war in Iraq. But, with rare exceptions, that has not been the case.

"We are about to lose our economic freedom and we can't find a single Republican with us," says Rep. John Tanner (D) of Tennessee, referring to this week's expected vote on the AMT.

In the Senate, Democrats say they want to abide by the pay-as-you-go rule, but don't have the Republican votes needed to demand offsets for changes such as the AMT fix.

Senate Republicans say the AMT was too big a problem not to fix. "It would be foolish to have to pass a permanent tax increase to make up for a tax that Congress never intended to collect," says Sen. Jon Kyl (R) of Arizona, commenting on the AMT fix.

Senators on both sides of the aisle note that, for now, federal revenues are higher than expected and make up for the AMT fix. But they admit that the 110th Congress has made little headway in dealing with America's longer terms fiscal problems.

"I hope that the next president plays a big role in helping us get it all in balance. It takes a president," says Sen. Max Baucus (D) of Montana, who chairs the Senate Finance Committee.