WASHINGTON (Reuters) - Republican leaders in the House of Representatives on Monday dropped their demand for spending reductions to pay for extending a tax cut for 160 million American workers, setting up a likely breakthrough for agreement with Democrats.
The about-face cleared the way for the Republican-led House to vote this week to renew for 10 months the tax cut set to expire on February 29.
The Democratic-led Senate would likely support the payroll tax extension as laid out by the Republicans, even though they prefer including in the deal provisions on jobless benefits and payments for doctors treating Medicare patients that Republicans now want to negotiate separately.
Notably, the offer was issued by both House Speaker John Boehner, the top Republican, and his deputy Eric Cantor, who has often taken a more hardline approach in budget negotiations with Democrats over the past year.
Republicans made deficit reduction a rallying cry during last year's budget battles with Democrats that brought the U.S. government to the edge of a shutdown three times and cost the country its coveted AAA credit rating from the Standard & Poor's rating agency.
Dropping the demand for spending cuts to finance the payroll tax cut could draw fire from conservatives within the party who oppose adding to a trillion-plus deficit.
The decision, however, allows Republicans to put behind them an issue that has divided them and hurt their tax-cutting image among voters before the November elections.
"They folded," a senior Democratic aide said. "Republicans know their ongoing handwringing on getting their members to support this tax cut is a loser for them."
Many economists said extending the tax cut through the 2012 election year was needed to shore up sluggish U.S. growth even as some Republicans questioned its economic value. The tax cut could inject about $100 billion into the U.S. economy this year.
If the impasse had persisted, President Barack Obama could have added it to his list of complaints about what he calls a "do nothing Congress," a central theme in his re-election campaign.
Public approval of Congress is at record lows and polling data show voters primarily blame Republicans, who control the House of Representatives.
"In the middle of the Republican presidential primary and the general election coming up, they didn't want to saddle their party with torpedoing a bill to extend a tax cut," said Dan Ripp of Bradley Woods, a private firm that tracks Washington for institutional investors.
Republican Senator Ron Johnson, a favorite of the conservative Tea Party movement, voiced concerns about adding the roughly $100 billion cost of extending the payroll tax cut to the debt but acknowledged that "there is such great political pressure" to extend the payroll tax cut.
Democrats have gained an upper hand in the battle over the payroll tax cut, using Republican opposition to a Democratic plan to pay for it with a tax on millionaires to portray them as favoring the wealthy over the struggling middle class.
The White House reacted cautiously to news of the Republican offer, first reported by Reuters, calling it "hypothetical."
Congressional Democrats said they would prefer to negotiate a comprehensive payroll tax cut package that also included an extension of unemployment insurance benefits and provision to continue pay at current rates for doctors treating elderly Medicare patients.
"Republicans are suddenly feeling the pressure to make sure middle class tax cuts are extended without delay," said House Democratic Whip Steny Hoyer. "But we cannot ignore Americans who are out of work through no fault of their own, or put at risk up to 48 million seniors' access to their doctors."
Talks on extending the 4.2 percent rate on taxes workers pay into the Social Security trust fund had stalled over how to pay for it, with both sides refusing to make significant compromises and accusing each other of bad faith negotiations. If Congress fails to extend the tax break, the payroll tax rate workers pay will rise to 6.2 percent on March 1.
Boehner and Cantor blamed Democrats for blocking agreement on spending cuts to cover the roughly $170 billion price tag of extending the payroll tax cut and unemployment insurance for a full year, along with keeping doctor payments under the Medicare health insurance program for the elderly at current rates.
"(This) has made it necessary for us to prepare this fallback option to protect small business job creators and ensure taxes don't go up on middle class workers," they said in a statement.
Republicans first made the compromise offer over the weekend, aides said.
A Republican aide said the party had been discussing the move for a week and decided to go ahead with the plan when weekend talks failed to produce a comprehensive agreement.
Talks over the weekend were held between Senator Max Baucus, the top Democratic negotiator, and Representative Dave Camp, the top Republican negotiator.
After the weekend discussions, Camp spoke by phone with fellow House Republican leaders, including Boehner and Cantor, and decided to move ahead with a separate payroll tax cut bill that doesn't include spending cuts to pay for it.
Negotiations will continue on averting a pay cut for doctors treating Medicare patients and on an extension of jobless benefits for the long-term unemployed, while also seeking a way to pay for the package, the Republican leaders' statement said.
A senior Senate Republican aide predicted that the House Republican leadership plan would win Senate support.
"We have said that tax cuts tend to pay for themselves and we should not be overly concerned with paying for them," the aide said.
"They (House Republican leaders) came to the same conclusion as we (Senate Republicans) did last December: it's not smart being seen as being opposed to a tax cut or demanding that they be paid for," the aide said.
Additional reporting by Richard Cowan; editing by Mary Milliken