Expired Payroll Tax Cut “Holiday”: New Survey Data Indicates Not Good News for the Economy

Despite both Congress’ and the White House’s constant rhetoric of “maintaining current tax rates for a majority of working Americans during the “fiscal cliff” negotiations, most working Americans are now taking home less pay as a result of the new 2013 legislation.  The two-year 2011-2012 payroll tax “holiday” failed to make its way into the final legislation resulting in a 2% payroll increase (from 4.2% to 6.2%).   Less take-home pay generally translates into, among other things, less spending.  At a time when the economy is still struggling, many economists agree that this is not a good thing.   But according the New York Federal Reserve Banks’ new survey data, the expiration of the payroll tax cut may be even worse for the economy than previously thought.

The New York Federal Reserve Banks’ new survey data indicates that the 2011 payroll tax cut resulted in Americans reportedly spending between 28 and 43 percent of the savings, significantly more than for previous tax cuts.  With the payroll tax cut now expired, the typical household consumption is expected to decline by a relative amount.

The new survey data also revealed significant demographic heterogeneity on how the extra 2011 savings was used (e.g., spent on consumer items, saved, pay off debtor).   In theory, some economic thought suggests that low-income and less-educated individuals would spend the tax cuts on needed consumer items (aka “liquidity constrained” individuals).  The White House apparently was a believer in this theory back in 2010 when it signed into law the Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 that, among other things, provided the payroll tax “holiday”.  The following remains posted on the White House’s website:

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010:
Win for Women, Mothers and Working Families

The agreement announced by the President not only secures vital tax relief and investments in our workers that will create jobs and accelerate economic growth, it contains specific policies that provide targeted support for working families, particularly women and mothers…

Economic studies consistently find that lower-income households are the most likely to spend additional money, creating jobs and helping overall growth. That’s why the Congressional Budget Office has concluded that “policies aimed at lower-income households tend to have greater stimulative effects.”

Beginning in the Recovery Act, the President has demonstrated his commitment to extend benefits and tax cuts to struggling families as the right thing to do for family security and our economy…Not only do these provisions help strengthen the economy by promoting work and putting money into the pockets of working families who eventually put it back into the economy through consumption, they are also effective at improving the health of families…

The New York Fed’s new survey data contradicts this belief/theory.   Specifically, there was no evidence that low-income survey respondents spent proportionately more of their tax cut savings than higher income respondents.  Rather, it was the high-income respondents that spent proportionately more on consumer items.  Low-income respondents spent more on paying down their debt.

Recall that the new 2013 law just increased the Federal income tax rate to almost 40% for those making more than $400,000.  If these new survey data findings are applicable to the Federal income tax rates, this struggling economy may really struggle this coming year….

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