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WASHINGTON Tue. Feb. 7, 2012 6:50pm EST (Reuters) - Republican and Democratic leaders accused each other of bad faith negotiations on Tuesday as both parties played hardball in talks to extend a tax cut for 160 million U.S. workers.

"We are right back to where we were last December," when negotiations broke down during a previous payroll tax battle, Senate Majority Leader Harry Reid (D-Nev.) complained to reporters.

Both parties are betting that the other side will blink first, a replay of the brinkmanship during last year's budget battles 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.

Reid criticized Republican efforts to roll back some environmental regulations as part of the payroll tax cut effort.

He characterized the Republican strategy as: "'We'll give you a payroll tax cut ... if you will let us continue to put things like arsenic and mercury in the water.'"

His Republican counterpart in the Senate, Mitch McConnell (R-Ky.), retorted that if Reid was suggesting that Republicans were only willing to extend the tax cut if "they're allowed to poison Americans' drinking water, then I think it's pretty safe to say that they (Democrats) are the ones who've veered away from good faith negotiations."

The fight, a continuation of last year's bitter dispute over President Barack Obama's payroll tax cut initiative, carries major ramifications for the U.S. economy and for Democratic and Republican re-election prospects in November.

Extending the lower tax rate through 2012 would give the average U.S. family about $1,000 more in spending power. That in turn would inject more than $100 billion into the U.S. economy at a time when it is showing signs of strengthening.

Some economists think the legislation could add as much as one percentage point to economic growth this year if it also extends long-term jobless benefits, as is planned.

Only three weeks remain before the 4.2% payroll tax ratchets up to 6.2%, but in fact the deadline is even closer because Congress is scheduled to begin a nine-day recess starting on Feb. 18.

By next week, Democratic and Republican congressional aides are hoping that a bipartisan negotiating group will show progress toward a deal.

But Democrats, who feel they have the upper hand in the negotiations after scoring big with voters during last December's fight, could hold out, leaving it to House and Senate leaders to craft a final deal.

The fight in Congress is over how to cover the cost - roughly $170 billion - of continuing the tax cut for 10 more months, along with existing unemployment benefits and keeping Medicare doctor payments at current rates.

© 2010 Thomson Reuters. Click for Restrictions.

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