In 2010, Congress passed the Tax Hike Prevention Act, which among other things reduced the payroll tax from 6.2% to 4.2% starting in 2011. For two years, workers saw higher take-home income than they would have had the law never existed, and consumers responded favorably by using the extra money throughout the two years to save, invest, pay off debt, and spend.

Of course, short of burning bills in a bonfire, that’s all there is to do with money, if you consider charity to be spending.

The payroll tax holiday ended at the beginning of this year, and as a result, that treat in the form of higher net pay is gone. There are other variables that determine take-home pay, such as raises, new jobs, changes to withholding exemptions, but for those who pay payroll tax, if the law had been extended, net pay would be higher this year.

With less money in their pockets, consumers are spending less. The Federal Reserve Bank of New York surveyed 370 individuals with the intent of determining how this pay decrease is affecting consumers’ spending and saving habits. The economists are aware of the limits of self-reported surveys, so they use the information meaningfully. They compare the reported spending and saving behavior with the extra money during the payroll tax holiday with the reported behavior or planned behavior this year.

For example, of those who mostly spent their extra pay in 2011 and 2012 rather than mostly saved or mostly paid down debt, 86.2 percent are decreasing or planning to decrease their spending to compensate for this year’s higher payroll tax. Only 1.1 percent plan to make up for their shortfall by increasing their debt. Of those who mostly used their extra pay to reduce debt over the prior two years, only 80 percent plan to cut spending but 4.3 percent plan to increase debt.

The survey assumes that people understand their own financial situations and the implications of the payroll tax cut, and I have serious doubts that a random selection of 370 individuals is going to able these questions with accuracy. The self-reporting bias encourages people to answer the questions as if they were their “ideal self,” but beyond that, some might not be able to accurately describe their past behavior or predict their future behavior, despite good intentions.

Furthermore, the survey phone call might have been the first time some respondents had heard of the payroll tax cut, and some might not have noticed changes in their paychecks had someone not called to ask about it.

That’s why I like economic studies based on measurable behavior rather than self-reporting. I do find it interesting when studies compare self-reporting with actual, measured behavior; it tends to shed a light on how people don’t know or understand their behavior and how people have less control over their environment than they think.

Back to this survey from the Federal Reserve Bank of New York, another interesting point is how planned behavior differs depending on the respondents’ level of household income. It’s notable that the economists decided to use an annual income level of $75,000 to be the boundary between lower and higher-income households. In 2011, the median household income in the United States was $50,502 — but these economists are based in New York City, so maybe they’re making an unconscious adjustment for a higher cost of living in their own neighborhood.

Of these “lower-income” households, only half of whom have reported seeing a pay decrease this year, the average household plans to reduce their spending by 77 percent of their loss of income compared to last year. Among the higher-income group, where about two-thirds have seen a decrease in net pay, whether due to the elimination of the payroll tax cut or some other change, the average household will reduce its spending by only 64 percent.

On the surface, there’s nothing in the report that’s earth-shattering. With less money, people spend, save less, and increase debt. This year’s behavior is a reversion to behavior prior to the payroll tax holiday, so it appears that the Tax Hike Prevention Act did its job by temporarily changing consumers’ behavior, and that’s just a small part of the recession-inspired economic stimulus.

As more actual spending, saving, and credit data become available, researchers will be able to determine whether people’s actions are correlated to their self-reported intentions.

Have you noticed a decrease in your take-home pay this year? What variables affected your net pay besides the elimination of the payroll tax cut? How has it affected your spending and saving behavior? Are you struggling more this year?

Chart: Federal Reserve Bank of New York
Federal Reserve Bank of New York via CNN Money

{ 8 comments }