Congress returns to Washington this week to continue its short session before the November election, but political observers say lawmakers are unlikely to agree on a plan for taxes and spending, a stalemate that bodes poorly for the states.
Without such a deal, a number of tax hikes and spending cuts will automatically kick in Jan 1. If that happens, it would be devastating to the Minnesota economy, state finance officials say.
Many of those in Washington seem to want to avert what's known as the fiscal cliff, but there is little agreement on how to do it. Both political parties agreed to the automatic, across-the-board spending cuts and tax increases after House Republicans refused to raise the federal debt ceiling last year.
Leaders of both parties had hoped that the threat of a budget crisis would force President Barack Obama and Congress to agree on a deficit reduction plan. But nothing has happened.
Democratic U.S. Sen. Al Franken, who voted for the initial compromise, is one of several lawmakers who say the automatic spending cuts and tax increases would be devastating to the economy.
"We can't do this all at once without endangering our recovery and without perhaps slipping into a double-dip recession," he said. "We're going to have to address this. The question will be how."
That question is complicating a potential solution. Franken and other Democrats say they want the income tax cuts enacted under President George W. Bush to continue for those earning less than $250,000 a year. They would let taxes go up for people with higher incomes.
Republicans object to that idea. U.S. Rep. John Kline, who voted for the debt ceiling deal, said earlier this summer that he will not support any income tax increases.
"They're going to hold the entire economy hostage unless Republicans agree to a tax increase," Kline said. "Is a tax increase on anybody, let them pick the number for how wealthy you have to be, so important that they're going to send us over the cliff?"
As members of Congress continue to argue rather than negotiate, economists across the nation worry about the fallout that would result from inaction.
"If a whole set of laws aren't changed, the economy is going to go into a recession sometime after Jan. 1," said Tom Stinson, Minnesota's state economist.
Stinson said if Congress fails to act, not only will the Bush-era income tax cuts expire but so will the payroll tax cut, the alternative minimum tax credit, and the research and development tax credit. That means the average person would see about a 5 percent reduction in take-home pay after the first of the year, he said.
Taking that much money out of the marketplace would make people less likely to spend money, a drag on the economy that would be like tripling the cost of gasoline overnight.
"If you think about it, you go to bed December 31st and the gas prices are $3.50 a gallon; you wake up in the morning, and they're $10.35 a gallon," Stinson said. "That's the kind of shock that's set up here."
Decreased consumer spending and a resulting drop in sales and income taxes would deliver a hard blow to the state's budget -- forcing Gov. Mark Dayton and state lawmakers to make tough decisions on taxes and spending for schools, health care and other programs.
For his part, Dayton said the economy will blow apart if Congress and the president fail to reach a budget deal. But the governor said he's not worrying too much about the issue yet.
"I think because the consequences are so severe, Congress will have to act," Dayton said. "Regardless of the outcome of the presidential election, I think it will be pulled together simply because it has to."
Republicans in the Legislature are also taking a wait-and-see approach. State Sen. Julianne Ortman of Chanhassen said this isn't the first time Minnesota has been at the mercy of federal inaction.
Ortman said the standoff is causing many business owners to be skittish about investing, since they cannot plan budgets in the current tax climate.
"The biggest concern is the uncertainty that is associated with something like this," she said. "When you have such uncertainty in the economy, you have a lot of investors that are very reluctant to invest."
Another big question is whether Dayton will continue to push for an income tax hike on top earners if taxes go up on the federal level. Dayton has said he wants the state tax increase because he said it would make the system fairer.