What Ever Happened with the Payroll Tax Increase?

As you may recall, earlier this year, payroll taxes in the U.S. went up by 2% and I discussed how that tax increase could potentially affect spending.  Well, we’re done with first quarter, so how have consumers reacted to that $16 less (based on average weekly earnings on non-farm payrolls) in take-home pay each week?

  • Consumer spending increased the first two months of the year (up 0.7% in February and up 0.4% in January).
  • Consumer confidence took a temporary hit in January, and then generally recovered in February and March.

And, here’s the real kicker, according to a survey recently done by Bankrate.com, almost half of Americans surveyed (48%) didn’t even notice the payroll tax increase.  The households with the least income were even more unlikely to recognize the payroll tax increase than wealthier households (59% of households with less than $30,000 per year did not realize payroll taxes went up compared to 39% of middle-income households). A lot of lower-income households likely have variable hours worked and so their pay changes from check to check.  That’s at least part of the reason why they were less likely to pick up on the payroll tax increase when compared to households whose earners had steady paychecks.

All things being equal, this behavior isn’t what one would initially expect, so what gives?

First off, consumers do not live in an ”all things being equal” environment.   There are positive forces at work to offset that cut in income. The economy is doing pretty well.  Equity markets were robust in the first quarter. The housing recovery – both home construction and home prices – continues, as does the labor market recovery.  More jobs (or less layoffs), a better retirement portfolio, and more home equity are all good for the consumer.

In addition, consumer balance sheets were, on average, well prepared for a bit less income going into 2013. As of the end last year, consumer balance sheets were improving nicely – credit cards defaults were at lows not seen since 1994 and household financial obligations ratio (the ratio of monthly debt payments plus rents, leases, property tax, home insurance to personal disposable income) fell to historic lows.

So, where did we see changes in consumer behavior over the last couple months? One place is savings. From December to January, the savings rate plummeted (6.5%* to 2.2%) to near 2007 lows. The February savings rate did move up to 2.6%, but that’s still well below the trend we’ve seen since 2008 (4.6%). The caveat with this data is that it’s volatile and prone to revisions.  However, a decline in the savings rate may be consistent with less income. With less income, people save less or they’ll borrow to maintain a constant level of spending.  As mentioned above, consumer balance sheets have improved quite a bit over the last few years and are, on average, likely better able to absorb small changes in income.

Still, in the coming months, the little changes from the payroll tax increase could add up.  That permanent change in income could ultimately lead to a permanent small decline in consumption. Or alternatively, those positive forces, particularly the already-improving home prices and (if it happens) better wages could offset this effect.

*There was the added complication to this story; that is, income surged in December as companies paid out dividends and bonuses early to avoid income tax increases in 2013.  This increase was temporary; as a result people saved the extra money.