Payroll tax saps consumer outlook

It was the tax cut that nobody noticed two years ago. And it was rarely mentioned in the fight between Congress and the White House last year over the expiring Bush-era tax cuts. But this month, the payroll-tax cut suddenly registered on everybody’s radar screen — when it went away.

The Jan. 1 expiration of the 2 percentage point cut in the tax every worker pays to finance Social Security has prompted a huge drop in consumer confidence, wiping out all the gains registered in 2012, the Conference Board reported Tuesday.

Though long expected and not much discussed in Washington, the sudden tax increase appeared to take consumers by surprise.

Amid all the publicity about a $650 billion tax deal between Congress and the White House at the end of the year, some people apparently were expecting only “tax hikes on the rich” trumpeted by the media.

But the payroll tax provision — enacted as part of an economic stimulus deal between President Obama and Congress in 2011 — hit primarily middle- and low-income consumers, and for months had been singled out by economists as the most significant tax increase under consideration because it would hit more than 100 million consumers of modest means, not just the well-to-do.

“The increase in the payroll tax has undoubtedly dampened consumers’ spirits, and it may take awhile for confidence to rebound and consumers to recover from their initial paycheck shock,” said Lynn Franco, an economist at the Conference Board.

The board’s confidence index fell to 58.6 in January from 66.7 in December, its lowest level in 14 months. Confidence also slumped less noticeably in November and December as Congress and the White House engaged in battle over the tax package.

Chris G. Christopher, an economist at IHS Global Insight, called the dive in confidence a “super-bad” development that does not bode well for the economy.

“This is a major deterioration in confidence,” he said. “It is hard to find a silver lining,” with confidence about jobs, finances, home-buying and auto purchases all taking hits in the report, he said. “The new year has not started on a cheerful note. And consumer mood falls faster than it rises.”

The irony is the tax cut was noticed more in its absence than in its presence. Surveys at the time it was enacted showed that many consumers weren’t even aware of an increase in their take-home pay. But after two years of spending the extra cash from week to week, consumers clearly were missing the spare change, which added up to about $1,000 a year for the average taxpayer.

The confidence slump did not cause much concern on Wall Street, where it came as no surprise. An earlier report on consumer sentiment from the University of Michigan revealed the sharp consumer reaction to the tax increase. The markets focused on more upbeat news about the economy Tuesday, including a 10th straight monthly rise in home prices reported by Standard & Poor’s Corp.

But Matthew Shay, president of the National Retail Federation, said the loss of confidence likely foreshadows another dodgy year for consumer spending. He noted that just the fight over taxes in Congress, even before the tax hit people’s paychecks, caused a drop in confidence and spoiled what started out as a strong Christmas selling season at the end of last year.

The holiday season started with a bang, with record levels of sales around Thanksgiving. But the din from Washington over the budget and taxes in the weeks surrounding Christmas and New Year’s prompted consumers to withdraw from malls, bringing the shopping season to a weak end, he said. Spending rose by 3 percent during the holidays — an uninspiring performance, he said.

“The holiday season went head-to-head with Washington’s political wrangling over fiscal concerns, shifting consumers’ spending plans downward,” Mr. Shay said.

Since the battle over taxes and spending was not resolved at year’s end, with Congress postponing the deadline for $100 billion in across-the-board spending cuts until March, the same thing could happen this year, he said.

“What we witnessed during the holiday season is an indication of what we are likely to see in 2013. Consumers read troubling economic headlines every day and look at their bottom lines at the end of the month, and they don’t like what they see,” he said.

“Pushing fiscal policy decisions down the road will lead to even greater uncertainty, and will continue to impact consumers’ desire and ability to spend on discretionary items. The administration and Congress need to pursue and enact policies that lead to growth and economic expansion, or it could be another challenging year for retailers and consumers alike.”