Democrats, Republicans trade blows on tax cuts

Senate Majority Leader Harry Reid (D-NV) (2nd L) stands with Senator Charles Schumer (D-NY) (l) and Senator Dick Durbin (D-IL) (R) as he talks to reporters about the senate's vote on debt ceiling legislation at the U.S. Capitol in Washington, August 2, 2011.

WASHINGTON (Reuters) - Democrats and Republicans in Congress on Monday exchanged their first blows in a battle over extending a payroll tax cut for workers, the latest in a series of polarizing fights that has worried investors.

Democratic Senate Majority Leader Harry Reid warned that failure to continue the tax holiday would hurt U.S. economic growth and could, according to some economists, push the country back into recession.

The payroll tax cut for workers that went into effect at the beginning of 2011 has put about $1,000 in the average worker's pocket and helped to shore up consumer spending.

The Senate could vote on a measure extending and expanding it as early as Thursday, according to Democratic aides. The $255 billion cost of the legislation would be paid for with a new 3.25 percent tax on income over $1 million a year.

Republicans are expected to block it, in part because of the tax on the wealthy that they say will stifle job creation.

Senate Republican leader Mitch McConnell said Democrats should schedule votes on measures that have bipartisan support, instead of "symbolic show-votes that we know won't lead to anything except more tension and political acrimony."

The two parties have battled fiercely this year over the best way to improve the struggling U.S. economy and create jobs to reduce a 9 percent unemployment rate.

The acrimonious debates brought the United States to the brink of a first-ever debt default in August and stalled negotiations last week on a deficit reduction plan aimed at slowing the growth of the country's $15 trillion debt burden.

Fitch Ratings on Monday gave the United States until 2013 to come up with a "credible plan" to tackle its ballooning deficits or face the downgrade of its coveted AAA rating.

Some economists have warned that letting the payroll tax cut lapse could shave anywhere from 0.75 of a percentage point to 1.5 percentage points from economic growth. The latest economic data show that the U.S. economy grew at a 2 percent annual rate from July through September.

"The potential impact on the larger economy is downright scary," Reid said on the Senate floor.

Reid will have to find a way to gain enough support from Republicans, who are wary about allowing the tax cut for wage earners to expire ahead of the 2012 elections but do not want to add to already huge U.S. budget deficits.

MULTIPLE SENATE VOTES EXPECTED

If Democrats fail to win passage in the Senate this week, Reid said he would push for additional votes in December, before the current session of Congress comes to an end.

"We are not going to let this lapse," he said, predicting it could take up to three tries to pass a payroll tax cut extension.

Reid refused to comment to reporters when asked whether future versions of the legislation could try to pay for the tax cuts without targeting the very wealthy.

A Senate Democratic aide raised the idea of using future savings from U.S. troop withdrawals from Iraq and Afghanistan to help defray the cost of lowering the payroll tax. Using such future savings for current economic stimulus was discussed in the deficit-reduction negotiations that collapsed last week.

The current payroll tax cut that is set to expire on December 31 reduced workers' taxes, which are used to fund the Social Security retirement program, to 4.2 percent, from 6.2 percent.

Now, Democrats want to pare it back to 3.1 percent to put $1,500 in cash in the hands of about 120 million families.

Businesses would also get a tax holiday by cutting the 6.2 percent tax in half. To encourage more hiring, companies would not have to pay any payroll tax on newly hired workers under the Democratic plan.

While Republicans have either expressed opposition to cutting the payroll tax or been tepid to renewing it, at least one Republican said a deal was possible by year's end if it does not increase taxes on the wealthiest.

Senator Patrick Toomey, interviewed Sunday on ABC's "This Week" program, said, "I think probably some package of that with other features might very well pass." But he did not elaborate on a way to pay for a payroll tax cut he could support.

(Additional reporting by Donna Smith; Editing by Paul Simao)