By JANET HOOK And CAROL E. LEE
The White House and Senate Republicans are closing in on a budget compromise that would raise tax rates on couples making more than $450,000 a year, increase taxes on large inheritances and extend unemployment benefits for a year.
However, with the New Year's deadline approaching, negotiators were hung up on how, if at all, to postpone the $110 billion in spending cuts due to take effect Jan. 2.
The emerging deal, which was developed during all-night negotiations between Senate Republican Leader Mitch McConnell (R., Ky.) and Vice President Joe Biden, hasn't been embraced by senior Senate Democrats, and came under fire from liberals in the president's own party.
"The direction they are heading in is absolutely the wrong direction for our country," said Sen. Tom Harkin (D., Iowa).
The emerging compromise, described by people familiar with the talks, would permanently raise tax rates on households making more than $450,000 a year. It would also raise rates on capital gains and dividends for those households, from 15% now to Clinton-era levels of roughly 20%.
That represents a concession by President Barack Obama, who has long argued the income threshold for tax increases should be $250,000. He had offered a $400,000 threshold in earlier unsuccessful talks with House Speaker John Boehner (R., Ohio)
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Another component of the emerging deal would limit the number of personal exemptions as well as the value of itemized deductions, two restrictions that would kick in at $250,000 for individuals and $300,000 for couples. Those limits were abolished as part of the 2001 Bush tax revamp.
President Obama, in a statement from the White House, said negotiators had made "progress" over the last few days toward a deal.
"It appears that an agreement to prevent this New Year's tax hike is within sight, but it's not done," Mr. Obama said. "There are still issues left to resolve but we're hopeful Congress can get it done."
The president said negotiators on "the potential agreement" are still struggling to agree on a way to tackle the automatic spending cuts, known as the sequester, that are set to take effect in coming days.
He said the emerging compromise, which is far smaller than policy makers had hoped to achieve, would keep taxes from increasing on the middle class and lay a foundation for larger deficit reduction in the future.
"If Republicans think I will finish he job of deficit reduction through spending cuts alone... then they've got another thing coming," Mr. Obama said. "That's not how it's going to work. We've got to do this in a balanced and responsible way."
Negotiators have crafted a compromise that would set the estate tax at 40% on inheritances over $5 million, up from the 35% that applies now to estates over $5.12 million. That's not as high as the 45% rate Mr. Obama sought with a $3.5 million exemption.
The potential deal calls for a permanent fix to the alternative minimum tax, a one-year extension of unemployment insurance benefits, and a five-year extension of other tax breaks. It also would block a scheduled cut in Medicare payments to doctors for one year.
The sticking point in negotiations is how to handle automatic spending cuts set to take effect in the New Year. The White House wants a one-year delay that is offset by spending cuts and revenue raised through tax increases. Republicans want either no delay in the so-called sequester or for it to be offset entirely by spending cuts.
What happens Monday could go some way to determining the short-term fate of the U.S. economy and the reputation of the government, both of which have been tarnished by the spectacle of endless seemingly circular negotiations. In the past two weeks, at least three different sets of negotiation teams have sought a way out.
In a sign of opposition that could mount to any deal from liberal Democrats, Sen. Harkin took to the Senate floor to criticize reports that the compromise was taking shape in negotiations between Messrs. McConnell and Biden.
Still, some remained hopeful that elements of a deal were on the table and could be brought into alignment at the last minute.
Sen. Barbara Boxer (D., Calif.) urged colleagues not to "prejudge'' the outcome before the negotiations are complete.
"This is a compromise. We don't have a parliamentary system of government here,'' said Ms. Boxer, who like other Democrats from high-cost states, welcomes a compromise that raises the threshold on income-tax increases because $250,000 doesn't go as far in California as it does in other regions.
"I am hopeful that we will get something done,'' Ms. Boxer said. "If we do, and it is fair—fair enough—we should get our country off this cliff.''
Senate Majority Leader Harry Reid (D., Nev.) said earlier Monday on the Senate floor that discussions continue, but warned "we really are running out of time," adding "There are a number of issues on which the two sides are still apart."
In the absence of a bipartisan deal, Mr. Reid is preparing for a Monday vote on a bill to carry out Mr. Obama's backup proposal, which tackles only a few items on the legislative agenda, including extending current tax rates for income up to $250,000 for couples filing jointly. Democrats are confident they could pass the bill through the Senate. A key question is whether the House, which returned Sunday evening, would approve it if it doesn't enjoy broad bipartisan support in the Senate.
The fate of the spending cuts has been a lingering issue for days in the negotiations.
Sen. Bob Corker (R., Tenn.) said Sunday it remained a problem that Democrats wanted to spend the new tax revenue that would be raised by increasing the top rates. "All the money is being spent—it's not being used for any kind of deficit reduction," he said.
To address that concern, Republicans, in negotiations with Mr. Reid, resurrected a proposal to cut spending by slowing the growth of Social Security's cost-of-living adjustments. Mr. Obama, rare among Democrats, has shown some willingness to accept the idea, but only as part of a broader budget deal, not the kind of stopgap measure being devised in the Senate.
Mr. Reid was sharply opposed, and the proposal, which is known as "chained CPI," nearly brought the talks to a halt until Republicans withdrew the idea.
Sen. John McCain (R., Ariz.) said "we're closer than one would think" to a deal, but "we cannot win a PR battle where we are holding fast on tax breaks for the wealthiest people versus the chained CPI. It's not a winning hand."
Write to Janet Hook at janet.hook@wsj.com and Carol E. Lee at carol.lee@wsj.com
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