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Analysis: Payroll tax cuts seen doable, but boost modest

U.S. President Obama arrives to address a joint session of Congress on Capitol Hill in Washington
U.S. President Obama arrives to address a joint session of Congress on Capitol Hill in Washington

By David Lawder

WASHINGTON (Reuters) - The one component of President Barack Obama's jobs plan most likely to win approval in Congress -- payroll tax cuts -- will produce only a modest incremental lift to the U.S. economy and may barely nudge unemployment lower.

Much of the new spending in the $447 billion plan unveiled on Thursday night will face stiff opposition from Republicans, leaving the payroll tax cuts as the main hope for common ground between two parties still scarred by a grueling battle over raising the U.S. debt limit earlier this summer.

Under Obama's plan, businesses would get a holiday from payroll taxes for new hires and lower rates for existing employees, while workers would be spared the expiration of prior payroll tax cuts at year-end and receive a 1.1 percentage point reduction from current levels through 2012.

"Given the current environment, that seems the most likely area where they are going to reach agreement," said Michael Feroli, an economist with JPMorgan in New York.

To a good degree, the payroll tax cuts would simply fill the hole that would be left if the existing tax cuts expired.

Passage would add about 0.7 to 0.8 percentage points to U.S. gross domestic product in 2012 compared to a baseline that assumes the current cuts expire, analysts say.

But compared to the current level of economic growth that is supported by the lower payroll taxes, the plan would add only about 0.2 percentage points to GDP next year.

"Nothing that's likely to get done is going to have a meaningful impact in terms of lowering the unemployment rate and creating jobs," said Neil Dutta, an economist with Bank of America Merrill Lynch in New York.

Congress could even try to carve up the payroll proposals and pass only the employer portions and ignore the tax reduction for employees.

Still, passage of the payroll tax portions would help reverse what was expected to be a fiscal headwind for the economy in 2012, and could improve Obama's chances for re-election by helping to pull the jobless rate down below its current 9.1 percent.

The economy grew at less than a 1 percent annual rate over the first half of the year. And while many economists expect growth to perk up the third and fourth quarters, financial instability in Europe and slumping consumer confidence at home has heightened the risk of recession.

SPENDING MONEY

Some economists have questioned the effectiveness of the previous payroll tax cuts, arguing that a few extra dollars in each paycheck was not enough to spur significant purchases or was simply saved by consumers trying to dig out of debts.

"I think it does get spent," Barclays Capital economist Troy Davig said of the extra cash from payroll tax cuts. "It completely cushioned the higher oil and gasoline prices this year and without it we would have been close to negative growth."

"A lot of people are living paycheck-to-paycheck and as their disposable personal income rises, they spend the incremental amount," he added.

The impact on jobs is less clear. The most optimistic estimate came from Mark Zandi, chief economist for Moody's Analytics, who said the employee portion of the payroll tax cut plan could add 750,000 jobs and the employer portion could add another 300,000.

Other analysts were hesitant to put a number on the expected job-creating power. The employer portion is aimed at nudging firms who were mulling expansion into action by effectively lowering their incremental labor costs.

Davig noted that many firms have been holding back due to the clouded outlook for final demand in the economy. A temporary tax holiday may not be enough to overcome this.

"Hiring is a long-term contract and this a short-term stimulus," he added.

(Editing by Andrea Ricci)

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