WASHINGTON (Reuters) - You would never know it from all the hot air rising out of Washington, but President Barack Obama and congressional Republicans could easily reach a deal to raise the debt limit and avoid an early August default.

Before talks hit a brick wall last weekend, negotiators were tantalizingly close to a $2 trillion-plus budget deal that would enable Congress to sign off on further borrowing, according to Democratic and Republican sources.

Since then, things have not looked good. Obama compared Republicans to lazy schoolchildren and Democrats accused them of deliberately sabotaging the economy. Republicans have not shied away from salty language, either.

"Washington is addicted to spending, and the addict-in- chief is the president,"Republican Senator Jim DeMint said on the Senate floor on Thursday.

Analysts worry lawmakers may be painting themselves into a corner. "In order to get out of this mess they're going to have to eat some of their words," said Joe Minarik, a former budget official in the Clinton administration.

The Treasury Department has warned the country will face default if Congress does not lift the $14.3 trillion debt ceiling by August 2. That could push the country back into recession and upend financial markets across the globe.

Whether Republicans and Democrats can bridge their differences over the coming weeks remains to be seen.

From a dollar standpoint, the two sides are closer to a deal than it might appear.

In talks led by Vice President Joe Biden, negotiators had agreed to reduce discretionary spending, which covers everything from space exploration to pollution control, by between $900 billion and $1.7 trillion over 10 years.

Republicans resisted cuts to military and other security spending sought by Democrats, but Senator Charles Schumer, a Democrat known as a hard-nosed partisan, said on Thursday he thought a compromise was possible in this area.

The two sides had also tentatively agreed on cuts to a wide range of benefit programs, such as farm subsidies, student aid and federal employee retirement plans -- a total of roughly

$200 billion, according to Democrats.


Democrats have hammered their conservative opponents over a Republican proposal to scale back the Medicare program for future retirees, but the budget talks have yielded some consensus in this area as well.

Democrats say the deal could save roughly $200 billion through structural changes to health programs like Medicare and Medicaid, the healthcare program for the poor and handicapped, that don't scale back benefits.

Both sides have also taken a look at changing the inflation index, which could slow the growth of benefit payments and tax exemptions. That could yield $300 billion.

The lowered spending levels would reduce the amount the government spends on interest payments. That could yield a further $400 billion or so in savings, according to a back-of-the envelope calculation.

That adds up to at least $2 trillion in cuts -- roughly enough to ensure that Congress would not have to revisit the politically toxic issue before the November 2012 elections.

The main sticking point is tax increases. Republicans leaders have said they're off the table, and Democrats no longer expect to get the increase in income-tax rates for wealthy households that they had initially sought.

Instead, they aim to close a range of tax breaks that could generate $400 billion in new revenue. Republicans are not likely to agree to the largest of these, which would generate $300 billion from wealthy taxpayers by limiting the amount of deductions they can claim.

But other breaks for corporate jets, yachts and racehorses have a minimal impact on the budget and provide Democrats with vivid fodder for campaign attack ads. Throwing a few of these into the deal could avert a few headaches for Republicans and allow Democrats to claim a moral victory.

"It's going to be a difficult lift, but I still think that calmer minds will prevail in the end and they'll recognize that we don't have any alternative but to move forward," said Bill Hoagland, a former Republican congressional aide who has worked on budget issues for decades.

(Additional reporting by Alister Bull and Deborah Charles; editing by Todd Eastham)