President Barack Obama is “hopeful” that a solution will be found quickly to avoid a so-called “fiscal cliff” of tax rises and spending cuts.
The White House said it would work with Congress to strike a bipartisan deal ahead of a 1 January deadline.
Earlier, Republicans dropped a vote in Congress on a proposal that would have raised taxes on high earners.
Right-leaning Republicans rejected the plan, which was put forward by Republican House speaker John Boehner.
Analysts say the rejection has weakened Mr Boehner’s position in negotiations with the Obama administration.
Mr Boehner’s plan would have had little chance of passing a Senate vote, but was seen as an effort to tell the US public that the Republicans should not be blamed if a deal could not be reached.
The House is controlled by the Republicans, but the Senate is Democrat-led.
‘Protect the economy’
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What happens now depends on whether President Obama’s foot soldiers are as willing to play chicken with the recovery as Mr Boehner’s troops seem to be”
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If politicians fail to agree new fiscal rules by the end year, steep tax rises and deep spending cuts are meant to take effect automatically.
Analysts say the resulting “fiscal cliff” could take the US into recession.
Despite the failure of Mr Boehner’s proposal, major stock markets were little changed, as most analysts had expected this to be a long drawn-out process.
European markets were down in the first half hour of trading, but by less than 0.5%.
The White House said President Barack Obama would work with Congress “to get this done”.
“We are hopeful that we will be able to find a bipartisan solution quickly that protects the middle class and our economy,” it said.
What is the fiscal cliff?
- On 1 January 2013, tax increases and huge spending cuts are due to come into force – the so-called fiscal cliff
- Deadline was put in place in 2011 to force president and Congress to agree ways to save money over the next 10 years
- Fear is that raising taxes while massively cutting spending will have huge impact on households and businesses
- Experts believe it could push the US into recession, and have a global impact on growth
- Q&A: The US fiscal cliff
- Why is it called a ‘fiscal cliff’?
The House of Representatives is not expected to meet until after Christmas, while the Senate was due to meet only briefly on Friday.
Although Mr Boehner’s proposal would have ensured a tax cut for 99.8% of Americans, it would have imposed a rise on those earning more than $ 1m (£600,000).
Mr Boehner said he had been unable to garner sufficient votes to secure passage of the bill.
Mr Obama initially sought tax rises for those earning more than $ 250,000, but later offered a compromise threshold of $ 400,000.
He also offered a change to the way Social Security cost of living adjustments are made for some recipients, cuts from government healthcare programmes and a two-year extension of the debt ceiling.
‘Non-starters’
Mr Boehner announced his bill on Tuesday, saying he would bring forward a measure that extended Bush-era tax cuts for those earning less than $ 1m per year – but would not address the automatic spending cuts.
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Mr Boehner has no alternative but to return to negotiations with Obama, his moral authority shredded but his bargaining hand curiously strengthened”
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On Wednesday, the Republican leadership added a companion bill that would replace the automatic cuts with a proposal to remove cuts from defence and government operating budgets. They would be offset by reductions elsewhere in the budget.
The proposal would cut food stamps, benefits for federal workers and some social services programmes.
That bill was narrowly passed.
Senate Majority Leader Harry Reid said Mr Boehner’s plans were “non-starters in the Senate”, while White House spokesman Jay Carney called them a “multi-day exercise in futility at a time when we do not have the luxury of exercises in futility”.
Analysts have painted a grim picture of the consequences of going over the cliff, with some warning that the impact could push the US back into recession.
The Organisation for Economic Co-operation and Development (OECD) said in its latest economic outlook that the recession from the cliff could become global.
Changing taxation across the years | ||||||||
|---|---|---|---|---|---|---|---|---|
| Tax year | 1993-2000 | 2001 | 2002 | 2003-2008 | 2009-2012 | 2012 tax brackets | 2013 scenarios | |
| Source: Tax Foundation, IRS Tax brackets shown for unmarried individuals | ||||||||
| President |  Bill Clinton |  George W Bush |  Barack Obama | Tax cuts expire | Tax cuts expire for top incomes | |||
| Bottom rate | 15% | 15% | 10% | 10% | 10% | Up to $ 8,700 | 15% | 10% |
| 15% | 15% | 15% | $ 8,700-$ 35,350 | 15% | ||||
| 28% | 27.5% | 27% | 25% | 25% | $ 35,350- $ 85,650 | 28% | 25% | |
| 31% | 30.5% | 30% | 28% | 28% | $ 85,650- $ 178,650 | 31% | 28% | |
| 36% | 35.5% | 35% | 33% | 33% | $ 178,650-$ 388,350 | 36% | 33% | |
| 36% | ||||||||
| Top rate | 39.6% | 39.1% | 38.6% | 35% | 35% | Over $ 388,350 | 39.6% | 39.6% |
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