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Elimination of the Payroll Tax Cut Reduced Consumer Spending

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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

Published or updated May 16, 2013.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 9 comments… read them below or add one }

avatar 1 Anonymous

While I did see a decrease in my take home pay, it wasn’t that much to affect my decisions. I only noticed it for a few paychecks, but then I got a raise, so that counteracted the decrease. My spending habits have not changed not have my savings habits, so the tax holiday was a mute point for me.

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avatar 2 wylerassociate

My takehome pay decreased by 30 dollars so it did affect some decisions. I got a raise which didn’t completely counteract the payroll tax cut. My spending habits have changed.

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avatar 3 Anonymous

I am not part of Social Security although my wife is. My pay increased or really was restored to three year ago levels. For the last 3-4 years, I have been forced to take furlough (unpaid ) days. So my net actually increased. My wife did see a hit, however a raise made up for it. No change in spending habits, but I did save more.

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avatar 4 Anonymous

We haven’t changed a thing about our spending or saving habits. I’m not sure what we adjusted to absorb the lower paycheck. I guess we just have less for incidentals. In our younger paycheck-to-paycheck days this change would have been pretty damaging to our tight budget.

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avatar 5 Anonymous

When they made that 2% cut I made sure not to include it in my budget. It stinks that it went away, but I never thought it was a good idea to begin with.

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avatar 6 Anonymous

We cut spending, absolutely.

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avatar 7 Anonymous

We are self-employed, so we get the pleasure of pulling out the entire amount. We never adjusted it so we either saved the extra we had or reinvested it in our business. Since we really did not live off of it we really did not feel the change as we were already pulling that amount out anyway.

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avatar 8 qixx

We cut some of the other payroll deductions to adjust. Paying Dentist out of pocket for one, No vision insurance this year.

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avatar 9 Anonymous

I know I certainly spent less this year because of it. I got a raise last year and it was pretty much wiped out due to the increased payroll tax when the credit expired, so I definitely didn’t increase and probably have actually cut my spending so far.

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