Smart Spending, Taxes

Payroll Tax Holiday Ends; Consumer Spending Slows

In 2011 and 2012 those earning an income in the US saw a decrease in their taxes.  As a part of the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010 the taxes that go toward Social Security (also known as the FICA taxes) dropped from 6.2% of a person’s gross income down to 4.2%.  At the end of 2012 this holiday expired and those taxes went back up to 6.2%.  The first paychecks of 2013 reflected the changes, and many Americans noticed that they have smaller paychecks.  Those smaller paychecks are affecting how people spend money.

The impact, while not huge, is significant to many people.  For instance, a person earning exactly $50,000 per year will see an increase of$1,000 more paid in than they did last year.  This equates to about $38 per paycheck.  The surprising part of this tax “increase” is that when people’s paychecks went up in 2011, hardly anyone noticed.  But they did notice them go down in 2013.  This is a concept called Loss Aversion, where the joy of a gain has less of an impact than the disappointment of a loss.  Regardless of when or how it was noticed, the outcome is that many people have been cutting back on their spending.  They are eating out less, buying fewer non-essential items, and discretionary spending is down.

The silver lining, however, is that the tax has the biggest impact on the spending habits of the lowest wage earners.  The top 40% of the households account for 61% of consumer spending.  This means that even though their paychecks have gone down, they have more discretionary money to spend anyways.  So when their checks go down a little bit, they do not change their spending habits as much.

Toward the end of 2012 consumer spending started to slow.  In January spending was still increasing, however it was increasing very slowly.  As people start to realize that their paychecks are staying lower than they were last year, there will be more people who cut back on the little luxuries in life.  It is still too soon to tell exactly what the impact will be, but many companies are projecting earnings that are lower than they were last year.

More money taken from each paycheck means less money that can be spent on other goods.  While the purpose for implementing the payroll tax holiday was to increase consumer spending and help to prop up the recovering economy, will the reversion have the opposite affect?  There is still about a month left in the first quarter of 2013.  That is plenty of time for the economy to pick back up.  But what many economists are wondering is whether or not lower consumer spending is due to slightly lower paychecks, or is it due to general uneasiness about the future of the stock market and the US economy?  Did your spending habits change when you saw less in your 2013 paychecks?  Maybe now is a good time to implement some other cost cutting measures, or even better, earn more on the side.  Just a couple hours per week will replace that lost income.