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Obama's Payroll Tax Cut Signals Shift to Supply Side

By John Melloy, Executive Producer, CNBC's Fast Money

Wall Street cheered President Obama's fiscal compromise with Republicans -- not just the extension of the existing Bush-era tax cuts, but the addition of a payroll tax cut in particular, as that measure may signal an even bigger shift on the part of the White House toward supply-side economics.

"The payroll tax cut was a surprise to most and perhaps a sign that the administration is willing to try the other side's potion to get job growth back in the U.S.," said Bill O'Donnell and John Briggs, RBS bond strategists, in a note to clients. "There has been an endless debate among economists over the differences between private versus public sector multipliers. Looking at the just-announced tax compromise, it appears as if the markets will now get to see first hand what the debate's all about. The mid-term elections have apparently driven a shift away from public sector support (stimulus) to letting the private sector take a turn at the wheel with a heavier wallet."

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President Obama's deal keeps the lower personal income, dividend and capital gains rates enacted under President George W. Bush the same for at least the next two years. What's new is a 2 percent reduction in social security payroll taxes for one year.

The deal represents "a significantly more positive fiscal outcome for 2011 than we and most others have been expecting, including a one year reduction in the payroll tax," said Jan Hatzius, chief U.S. economist at Goldman Sachs, in a note. "This proposal would add $185 billion in stimulus in 2011 beyond what we have been assuming, not including the corporate tax provisions."

Stocks flirted with new highs for the year following the announcement as investors bet this fiscal stimulus, coupled with the Federal Reserve Chairman's monetary stimulus, will foster a one-two punch for the economic recovery next year. Stocks most linked to economic growth, including industrials and technology shares, led the gains.

If Obama is 'going Clinton' then it is hugely constructive for the economy," said Steve Cortes, founder of Veracruz LLC. "Once it was evident that Clinton would move to center and play ball with GOP, S&P soared in 1995 after 1994 mid-terms."

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