Obama: A president ready for a showdown by Tory Newmyer @FortuneMagazine August 16, 2012, 9:16 AM EST E-mail Tweet Facebook Google Plus Linkedin Share icons FORTUNE — President Obama started his first term with a bang, simultaneously engineering an auto industry rescue, stabilizing a teetering Wall Street, and negotiating a massive stimulus package to wrench the economy back from the brink. The experience may be useful if he is reelected. That’s because he’ll face the pileup of policy shocks known as the fiscal cliff even before he can be sworn in again. The looming crisis is a Beltway creation that both sides have anticipated since last year, when congressional negotiations toward a deficit-cutting accord imploded. But unlike last summer’s clash over the debt ceiling, when a faction of House Republicans was willing to let the U.S. default in order to force deeper spending cuts, the administration now has the upper hand. This time around, Republicans are the petitioners, eager to avert both a tax increase on income above $250,000 and scheduled cuts to defense spending. And the President is looking to use the challenge as a chance to tackle long-standing problems. Obama wants to apply his leverage to accomplish three things: a sweeping deficit-reduction agreement, a major investment in infrastructure and other spending to give the economic recovery a jolt, and a simplifying rewrite of our tax code. “People need to understand this can be an opportunity,” Gene Sperling, the President’s top economic adviser, tells me as he munches vending-machine Cheerios in his cramped West Wing office. (The White House made several senior aides available for interviews, but not the President.) “Historically, major budget agreements have often taken place when everyone felt there was a fiscal gun to their heads.” MORE: Mitt Romney’s 5-point plan for the economy Obama’s first priority will be a long-term plan for stemming the federal government’s tide of red ink. The administration hopes to secure $4 trillion in deficit reduction over the next decade, in part by raising $1.5 trillion in new revenue from higher taxes on upper incomes and closing loopholes in the tax code. But exactly how the President would squeeze entitlement spending remains an open question. Obama has walked away from concessions he offered the GOP last summer, including raising the eligibility age for Medicare and ratcheting back Social Security benefits. Instead, in his most recent budget, he proposes saving on health care programs mostly by cutting payments to providers. Whatever its final shape, however, such a deal alone would give business enough confidence to unleash a wave of hiring and investment, White House economic advisers argue. The President will also be pushing for passage of an ambitious set of spending proposals — based on a $447 billion package of targeted tax cuts, infrastructure spending, and aid to state and local governments dubbed the American Jobs Act — that remains the backbone of his plan to put people back to work. When Obama unveiled the bill last September, independent economic analysts predicted it could supply up to 1.9 million jobs and add two points to the GDP. The decision to pursue it marked an inflection in his presidency — the moment he abandoned a strategy of accommodation in favor of what he viewed as a clarifying confrontation with Republicans. Obama had spent the previous summer tangling with the GOP over its austerity agenda. It was frustrating for the President, aides say. He felt diminished by the grinding talks toward a debt agreement because they prevented him from getting back on a jobs message as the economy stumbled. As his team worked behind the scenes crafting new proposals to prop up the flagging recovery, Obama told them not to “self-edit.” The message: Don’t pre-negotiate compromises to entice Republican support, as they had on the first stimulus. When the President’s talks with House Speaker John Boehner finally fell apart in late July, he dived into the process of finalizing the details of the new bill. “The notion that the President had a heavy pent-up demand to get out there on jobs was an understatement. He was fired up,” Sperling says. Obama unveiled the package to a joint session of Congress in September, then barnstormed the country in support of it, but aside from extensions of the 2% payroll tax cut and unemployment benefits, it didn’t budge on Capitol Hill. The White House now believes it will have a chance to revive his proposals in the budget negotiations. MORE: Forget Washington – here’s how we’d fix the economy If the administration’s top priority, post-election, is securing a major compromise on the deficit, its second priority will be to force as much of the American Jobs Act into that as possible. It isn’t clear yet which pieces of the bill the President will push to include. If the growth forecast for next year remains gloomy, Obama could seek to extend the payroll tax cut yet again. But he’d prefer not to. The cut supplies a quick bolt of energy — a sort of economic sugar high. Instead, the White House favors spending that can swell employment rolls immediately while also meeting long-term needs like rebuilding roads, bridges, and schools. Economists of all stripes agree on the primacy of high-functioning infrastructure to promote growth. And yet America’s is crumbling. In just the past decade the quality of U.S. infrastructure has fallen from fifth worldwide to 24th, according to a recent report by the Council on Foreign Relations. In his jobs bill Obama proposes spending $60 billion on upgrades, including $10 billion for an infrastructure bank, a government entity that would offer loans and guarantees to kick-start private projects. Covering the campaign bases: President Obama holds a baby in Poland, Ohio. Getting all that into an already difficult budget deal would be a tall order. But the package could be bigger still. The last comprehensive rewrite of the nation’s tax laws came 26 years ago, and the code has since become a sprawling mess larded with special-interest carve-outs and other costly preferences. Tax writers on Capitol Hill are already working on a wholesale update, and there is a surprising amount of bipartisan agreement in principle about what the corporate side should look like. Both parties agree that the top corporate rate should be no higher than 28% and want to pay for lowering it by getting rid of preferences in the code. Obama hasn’t fully accounted for which ones he’d scrap, though he has called for limiting itemized deductions for the wealthy to 28%, taxing the earnings of hedge fund managers and private equity partners as ordinary income, and zeroing out breaks for oil and gas companies. And he wants to add new breaks for domestic manufacturers, including capping their tax rate at 25%. So that’s a landmark deficit-reduction agreement, major new investments in infrastructure, and a quarter-century’s worth of reform to the tax code. You have to wonder whether Obama could get it done at all, let alone before his second Inauguration. Reflecting on his first term in an interview with CBS last month, Obama said he had made a mistake. He had thought, he said, “that this job was just about getting the policy right. And that’s important. But the nature of this office is also to tell a story to the American people that gives them a sense of unity and purpose and optimism, especially during tough times.” It’s odd that such a masterful storyteller forgot to tell a story. Bogged down in legislative wrangling, he frequently neglected his most powerful tool: his ability to go over the heads of the fractious Beltway crowd and take his case directly to the American people. He had run on a pledge to end an era of crippling partisanship, and he had won the White House with a huge army of volunteers. The care and feeding of that ground force shifted to the Democratic National Committee once Obama took office, but the party never quite figured out how to translate the popular energy that inspired his campaign into an instrument to advance his legislative agenda. MORE: Is Obama or Romney a better leader? How to judge. It’s an error Obama is determined not to repeat if he wins a second term. To that end, his team is prepping a major post-election mobilization to preserve the campaign’s momentum and keep the heat on Congress during the budget talks. The plan is to retain about 150 of the campaign’s sharpest operatives on payroll, deployed across the country to organize grass-roots support behind the President’s agenda, people briefed on the plan say. “Whether you’re organizing people to vote or organizing people to try to encourage their representative to support or oppose something, it’s the same thing,” says one, who wasn’t authorized to discuss internal deliberations on the record. And Obama appears poised to match that tactical gambit with a new toughness at the negotiating table. Progressive operatives who have complained that the President was too eager to cut deals with the GOP in his first term have emerged from conversations with the administration over the summer convinced that he has steeled himself for a showdown. The official line from the White House remains that the administration hopes to reach an agreement before the end of this year to avert the expiration of the Bush tax cuts for the middle class and the slashes to defense and other spending. But it has also made clear to allies that it will let the changes occur if Republicans won’t move sufficiently to meet its terms. The approach would give Democrats an advantage in the tax debate: By allowing all the cuts to expire, they could pursue reinstating lower rates for all but the highest incomes as a new tax cut next year, a proposal Republicans would be hard-pressed to oppose. It seems likely that both sides will agree to move the deadline for action into 2013 to give themselves more time, but top Democrats say Obama is keen to keep the pressure on by limiting any delay. “You have conditions that are extraordinarily propitious in terms of the political system coming together,” says former Treasury Secretary Robert Rubin. “But if you delay it for six months or a year, the odds of a constructive response go way, way down.” Obama could get an additional boost from an unlikely source: the business community. Corporate chiefs largely stayed out of the deficit fight last summer, believing the brinkmanship over the debt ceiling was just political theater. “All of us were shocked at how out of hand it got,” Honeywell HON CEO David Cote says, “and if they were playing with fire before, they’re playing with nitroglycerin now.” Cote is recruiting other CEOs to a campaign called Fix the Debt, dedicated to promoting a solution along the lines of the proposal by the Simpson-Bowles commission, a framework Obama has mostly, if belatedly, embraced. The group has already raised about $20 million in personal contributions from CEOs and enlisted a roster that includes Eaton CEO Sandy Cutler, Invesco IVZ CEO Martin Flanagan, and Aetna AET CEO Mark Bertolini. There’s no question the President’s relationship with business executives remains strained. “Most CEOs say the difference is this administration, starting with President Obama, has an abiding faith in the creative genius of government to make decisions that will get the economy moving,” says John Engler, president of the Business Roundtable. But the Obama team believes there would be plenty of chances to make common cause with business interests in a second term — on new investments in infrastructure and federal research agencies, immigration reform, and promoting workforce training through community colleges, among others. The Obama team knows it will have to move quickly. History suggests that the opening months of a new presidential term are the ripest for a big budget compromise, and that such a deal can become a vehicle for other priorities. Bill Clinton, for example, spent the start of his second term hashing out a balanced-budget agreement with Republican leaders that also cut capital gains taxes (a sweetener for the GOP) and launched a program to provide health insurance to children — a consolation prize for Clinton after the failure of his first-term health care reform drive. The precedent is fueling hope among senior Obama officials that there could be a dynamic shift toward deal cutting after the election. “The only way to break the fever is for voters to decide whether wealthy Americans should pay their fair share toward deficit reduction and economic growth, instead of putting it all on the back of the middle class. That’s the choice in this election,” says Stephanie Cutter, Obama’s deputy campaign manager. “Does that mean it will change the way Republicans act in Washington? Quite possibly, because I don’t think they’re benefiting from the gridlock right now.” MORE: Wall Street on Paul Ryan – careful what you wish for It’s a point Obama has been making explicitly on the campaign trail. The election, he told a small crowd gathered in Parma, Ohio, on July 5, is offering “two fundamentally different visions about how we move the country forward. And the great thing about our democracy is you get to be the tiebreaker.” It remains to be seen whether lawmakers will see it the same way. Congressional deadlock may seem absolute now, but there are signs it could get even worse next year. Moderates are heading for the exits, with ideologues primed to replace them. Campaign operatives on both sides predict the contest for the White House itself will be a squeaker, meaning if Obama wins, it will be with a majority far shy of his 2008 electoral romp — hardly a prescription for a muscular presidential mandate. Given that backdrop, some of the President’s allies are wringing their hands over a campaign that has so far felt attritional. The summer months have seen a ceaseless spew of attack ads from both sides, while the daily back and forth fixes on the latest micro-gaffe. (A new low earlier this month: The candidates stooped to playground-worthy name-calling; Obama labeled his challenger “Romney Hood,” a reverse Robin Hood, and Romney fired back that the critique was “Obamaloney.”) When you observe the race, it’s difficult not to notice the gap between the specificity with which Obama’s economic team in the White House is thinking through second-term scenarios and the vague treatment the next four years are getting on the trail. “I have to believe, and this surprises me, that the Obama team has concluded their economic narrative is not strong enough to sustain their campaign,” says Bill Galston, who was a senior adviser to President Clinton. Neera Tanden, president of the Center for American Progress and a former adviser to Obama, warns, “It matters what he campaigns on, because you can’t claim a mandate for doing things unless you talk about them in the election.” Obama addresses a rally in Parma, Ohio. Campaign officials insist a more sustained focus on policy is coming, during Obama’s speech at the Democratic National Convention on Sept. 6 and beyond. Romney’s decision to tap as his running mate Rep. Paul Ryan (R-Wis.), the House budget chief who’s emerged as a champion of conservative government reformers, seems to guarantee a meatier debate on the issues is at hand. But it’s also clear that the campaign to date has exposed a President transformed by his first four years in office. Gone is the post-partisan figure who promised to bring wholesale change to the political process. In his place is a candidate hardened by stalemate and energized by the prospect of a showdown with his opposition. A second Obama term will reveal whether confrontation yields more progress than conciliation — and we won’t have to wait long to find out. This story is from the September 3, 2012 issue of Fortune.