With time running short, President Barack Obama failed on Tuesday to break a deadlock in budget talks between his Democrats and Republicans that threatens a partial shutdown of the government.

In a White House meeting intended to break the impasse, House of Representatives Speaker John Boehner instead pushed for deeper spending cuts as part of a deal that would keep the government running past a Friday deadline, according to a Democratic source.

Though the two sides have been working for nearly a week on a package that would cut $33 billion from current spending levels, Boehner said he wanted that raised to $40 billion, the source said. Aides to Boehner declined to comment.

Democrats and Republicans had been at odds over just how those cuts would take effect, and now they must resolve the size of the cuts with only days to reach a solution.

Top lawmakers said they were losing hope that they can finalize a deal before funding expires at midnight on Friday.

I am not optimistic, no I'm not, Senate Democratic leader Harry Reid told a news conference.

Republicans and Democrats are locked in a game of brinkmanship over how to fund the federal government for the final six months of the 2011 fiscal year. Republicans are eager to fulfill a campaign promise to scale back government, while Democrats say sharp spending cuts could hurt the fragile economic recovery.

After the White House meeting, Obama said Americans wanted their leaders to act like grownups and cautioned that there was no excuse for not hammering out a deal in the next few days.

The dispute will set the stage for even bigger budget battles likely to last into the 2012 election campaign.

Republicans on Tuesday proposed an overhaul of government-run health programs, dramatic tax cuts and sharp spending caps in a budget plan for the next fiscal year, which starts on October 1.

Republican leaders hope that proposal will ease pressure from conservative members aligned with the conservative Tea Party movement who have shown little appetite for compromise in the negotiations.

THREAT TO EMPLOYEES

The deadlocked talks threaten to throw hundreds of thousands of employees out of work and ripple through an economy still recovering from the worst recession since the 1930s.

Boehner has disputed that he had agreed to a cut of $33 billion, though his staffers have been drawing up a package based on that figure. Republicans have said they will push for deeper cuts in exchange for dropping provisions that Democrats do not like.

We want the largest spending cuts that are possible, Boehner told reporters.

Republicans earlier had offered to push the deadline back by another week in exchange for an additional $12 billion in cuts, an offer Democrats dismissed as unreasonable.

Boehner and Reid met later to discuss the impasse in what aides from both parties described as a productive discussion.

Meanwhile, the White House warned federal agencies to make contingency plans in the event of a shutdown.

In the last government shutdown in 1995 and 1996, the military continued to operate and retirees continued to receive Social Security pension benefits. But passport offices, bankruptcy courts and national parks were shuttered, leading to millions of dollars in losses in the tourism industry.

This time around, troops might not get their paychecks even though the military would keep fighting in the wars in Iraq, Afghanistan and Libya, a Pentagon spokesman said.

Financial markets are unlikely to be affected by a shutdown as the Treasury Department would keep making debt payments, analysts said. But state and local governments could see their budget woes worsen.

Investors are more concerned that the government might be forced to default on its debt if Congress does not raise the country's $14.3 debt ceiling within the next few weeks. Failure to do so would be catastrophic, Treasury Secretary Timothy Geithner warned Congress.

Prediction market Intrade, which allows people to bet on the outcome of events, showed investors are gambling that there is a 60 percent chance the government will shut down by June 30, up from 40 percent earlier in the day.

Obama has been criticized by both parties for remaining aloof from the budget fight, which has consumed Congress since the beginning of the year.

His late entry into the budget battle marks an attempt to play the dealmaker and also to avoid blame if Republicans and Democrats fail to forge agreement in time.

The strategy follows the political logic of President Obama's whole career, which is to avoid messy battles which make you appear to be a partisan, said Ross Baker, a political science professor at Rutgers University.

Boehner, meanwhile, must keep his party unified in its first big test since Republicans won control of the House last November.

(Additional reporting by Jeff Mason, Caren Bohan, David Lawder, Rachelle Younglai, Donna Smith, Phil Stewart and Thomas Ferraro; Editing by Doina Chiacu, Ross Colvin and Christopher Wilson)

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