* Expiration would cost workers an average of $1,000 a year
* Seniors' lobby group AARP opposes extending tax cut
By Rachelle Younglai and Kim Dixon
WASHINGTON, Nov 15 (Reuters) - Support is mounting in the U.S. Congress, especially among Democrats, for extending a payroll tax holiday for 160 million Americans to protect workers from an immediate hit in their take-home pay at the beginning of next year, lawmakers say.
The payroll tax holiday, now in its second year, has been providing workers with an average of about $1,000 a year in extra cash.
The break will expire on Dec. 31 as part of about $500 billion in tax cuts that will expire and another $100 billion in automatic budget cuts that comprise the so-called fiscal cliff.
Keeping the tax holiday would somewhat reduce the recessionary impact of the cliff. But significant divisions remain on the payroll tax question in part because it funds the Social Security retirement program.
Any decision will be part of the fiscal cliff negotiations that start Friday when Republican and Democratic congressional leaders meet with President Barack Obama at the White House.
The payroll tax, dedicated to financing Social Security, is paid by employers and employees at a rate of 6.2 percent of wages up to a maximum of $110,110. The payroll tax holiday, enacted in 2010, reduced the rate by 2 percentage points on the portion paid by the worker.
Congress has since extended it through December.
Democratic Senator Kent Conrad told Reuters he backs extending the payroll tax cut because it would have "the biggest bang for the buck on economic growth," when compared with other ways to jump-start the economy.
Max Baucus, chairman of the Senate Finance Committee, told reporters the payroll tax cut extension needs to be "on the table," in any discussions over resolving the fiscal cliff.
Republicans might be put in a tight spot over the issue as they have been in the past. On the one hand, some Republicans argue the country could not afford its $100 billion-plus cost.
On the other hand, arguing against a tax cut, especially one that benefits workers, is difficult for a party that has made tax reduction a centerpiece of its political agenda.
Republican Senator Rob Portman this week said the payroll tax holiday had to be part of fiscal talks, and Democratic Representative Chris Van Hollen has long said the tax break would help the economy.
But there is division in both parties. One prominent Republican, Senator Orrin Hatch, a member of the Finance Committee, does not back an extension, according to his spokeswoman.
In the past, the Obama administration has been adamant about not extending the tax break for a third year in a row. On Thursday, a White House official said: "We have said we will look at the payroll tax cut in the context of the tax issues we are dealing with at the end of the year."
A major opponent of extension is the influential seniors' lobby group AARP, which has been pressuring lawmakers not to compromise the health of the retirement fund by extending the tax cut and including Social Security in debt reduction talks.
Some Democrats, including recently top House Democrat Nancy Pelosi, have shared that view.
AARP typically aligns itself with Democrats on preserving major government benefit programs.
"Further extension of the payroll tax holiday would undermine confidence in Social Security and put at risk the program's dedicated funding stream and the hard-earned benefits of millions of Americans and their families," AARP said in an October letter to lawmakers and the White House.
But with the U.S. economy still shaky, Democratic lawmakers are starting to agree that this tax break is needed to help the economic recovery.
"We need to do something on stimulus as part of the overall fiscal cliff. We have to do something because the economy's not growing fast enough," said Charles Schumer, a member of the Senate's Democratic leadership.
Many Democrats say if lawmakers decide to end the payroll tax cut, it could be replaced by reviving the Making Work Pay Credit. That $400 refundable tax credit, enacted as part of the 2009 stimulus bill, ended in 2011.
Jared Bernstein, former economic adviser to vice president Joe Biden, backs that view, he told the CNBC news program on Thursday. "This is not a great time to take a hundred-plus billion of stimulus out of the economy with the unemployment rate still elevated," he said