President Barack Obama's 2012 budget plan will bring a simmering deficit debate to a head when he sends it to Congress on Monday, but the United States is still far from tackling its huge fiscal gap as bond markets watch anxiously.

With the deficit expected to widen in 2011 and 2012 -- due largely to the December extension of George W. Bush-era tax cuts -- there is a risk of a damaging stand-off between Republicans and Obama's Democrats that produces little concrete action on the deficit.

Election wins in November by Republicans backed by the conservative Tea Party movement have brought new members to the House of Representatives who campaigned aggressively for slashed spending and smaller government.

Republicans control the House and Democrats have a majority in the Senate, which makes harder the process of finding a compromise on the budget proposal of Democrat Obama.

The top Republican, House Speaker John Boehner, already was attacking the White House budget effort. We're concerned he'll send Congress a budget that destroys jobs because it spends too much, taxes too much and borrows too much, Boehner told reporters on Thursday.

The current political landscape reminds me an awful lot of winter of 1995-'96, said William Hoagland, a budget expert who used to advise Republican senators. Back then, the government endured partial shutdowns after a Democratic White House and a Republican-led House could not settle their budget disputes.

The White House sees the budget as a starting point for the debate on spending and reducing the deficit, forecast to reach $1.48 trillion this fiscal year, or 9.8 percent of U.S. GDP. This would be down from 10.0 percent of GDP in 2010, but still very high for the United States on a historical basis.

There are a lot of different ideas on ...(Capitol) Hill right now that have started to develop over the last 10 days. I think we need to put our budget out there ... (and) focus on near-term deadlines, Obama's budget director Jack Lew told Reuters last week.

Obama's budget will include a five year freeze on non-security discretionary spending to lower the deficit by $400 billion over the next 10 years. But it will back investment in education, innovation and infrastructure, for example with $8 billion earmarked for high speed trains.

Republicans balk at Obama's spending plans and say his cuts do not go nearly far enough.

They are also critical of the White House's likely refusal to lay out a plan to tackle spending on entitlement programs -- Social Security, Medicare and Medicaid retirement and healthcare programs -- that many say will drive the deficit and debt to unsustainable levels unless they are reformed.

Senator Rand Paul, Kentucky's newly elected Tea Party Republican, said he had no qualms about taking a hatchet to those programs cherished by Democrats for providing a safety net to elderly and poor Americans.

Within two to three weeks, I'm going to propose a fix for Social Security, he told MSNBC this week. We're going to fix Social Security in one fell swoop for 75 years. Everybody knows how to do it. Everybody's afraid to do it. I'm unafraid to do it.

MARKET TWITCHES

Investors worry a mounting deficit means the government will have to issue more Treasury bonds to finance operations, potentially driving yields up and prices down.

Indeed, the bond market has suffered bouts of budget anxiety since late last year, contributing to a sell-off that pushed 10-year yields to 9-1/2-month highs on Wednesday, though a strengthening economic outlook has also played a big role, as some investors switch from the perceived safety of bonds into the riskier stock market.

Though on the rise, bond yields also remain well below historical averages, suggesting market worries over the budget are contained for the moment.

A key test of whether Republicans and Democrats can work together is a deadline in April or May by which time Congress needs to approve allowing more federal debt, or risk the United States defaulting on its borrowings that could cause economic havoc globally.

The White House wants to keep the debate over a long-term fiscal plan separate from the bill to raise the $14.3 trillion debt ceiling, and apart from legislation to replace a stop-gap government funding measure that expires on March 4.

Republicans also are divided on the issue, with the party's leadership wary of risking financial damage from a prolonged fight over the debt ceiling while their new Tea Party-backed colleagues are demanding concessions on spending cuts to pass the debt ceiling increase.

Boehner has made it clear he does not want wrangling over the debt ceiling bill to risk forcing the government to default.

But he could also try to weave language into the debt ceiling bill tying it to an upcoming fiscal 2012 budget blueprint the House will try to pass.

(Editing by Vicki Allen)

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