Correction: An earlier version of this post said incorrectly that for those earning over $113,700 each paycheck will decline by $87.46. The decline will vary among paychecks, though it will average out to $87.46 bi-weekly over the course of the year; however, the actual deduction may be higher at first and then stop when the worker hits the income threshold. This version has been corrected.
Many Americans received their first paycheck of 2013 today. That sound you hear is the collective “What the . .. “ they have emitted upon looking at their pay stub.
For all the self-congratulatory back-patting from the White House and Congress on the deal that averted the “fiscal cliff” of tax increases—the deal locked in the George W. Bush-era tax cuts for households making under $450,000—they tended not to mention what the deal did, or rather didn’t do, on the payroll tax. A 2 percentage point reduction in the Social Security tax, which hits all American workers, had been enacted at the end of 2010. In the fiscal cliff deal, Congress and President Obama neither extended it further nor agreed on any other policies that might have the similar effect of leaving more money in workers’ pockets.
The numbers, for anybody who hasn’t checked their paycheck yet (or won’t get paid in 2013 until later in the month): For someone who makes the U.S. average for private sector workers of $818.69 a week and is paid every other week, that adds up to a reduction of $32.75 in each paycheck. For higher earners, anyone making over $113,700 annually, the higher tax will average out over the year to the equivalent of each bi-weekly paycheck declining by $87.46; however, the actual deduction may be higher at first and then stop when the worker hits the income threshold.
The increase in payroll taxes has now gone from being an abstraction in Washington policy debates that politicians prefer not to talk about to being something very real.
The big question for the economy as 2013 gets underway is how America will react to their smaller paychecks. It is uncharted waters in many way: For most of the last two decades, taxes have been steadily falling. There is not much evidence for just how much Americans will pare back in response to tighter times and a higher tax burden.
One place to look for evidence is what happened when the payroll tax cut was implemented at the start of 2011. In the first six months of the year, personal consumption spending rose 2.2 percent, though that coincided with a spike in fuel prices tied to unrest in the Middle East, so when adjusted for inflation consumption spending rose only 0.6 percent. (In a way, it turned out to be lucky timing; in effect, the payroll tax break offset the economic drag that came from what turned out to be a temporary bump in oil prices.)
But the open question for the economy in 2013 is whether Americans adjust differently when their paychecks have a tax-induced decline than they did when they received a bump.
In terms of consumer psychology, behavioral economists speak of “loss aversion,” a tendency of people to be much more bummed out when they think they have lost something that belonged to them than if they gain it. A child might be much more upset to have a cookie taken away from them than they are happy to be given a cookie.
It is possible that as Americans learn of their lower take-home pay—either from reading news accounts around the fiscal cliff deal last week, or from opening their first paycheck of the year—they will adjust their entire spending plans for the year, which could make January a rough month for retailers and the economy as a whole.
In a new analysis, Goldman Sachs economists ran a number of different economic models to assess the impact of higher taxes from the fiscal cliff deal on the economy in 2013 (the payroll tax is the biggest, but they also included higher income tax rates on households making over $450,000 and some smaller tax provisions that reduce deductions for those making over $250,000). Those different models—Goldman’s in-house macroeconomic model, one used by the Federal Reserve, and analysis drawn from work by economists Christina and David Romer examining how consumption patterns have adjusted in the past to changes in tax policy—all find a hit to growth of around one percentage point in the first half of the year. Given that growth has been bouncing around at about 2 percent since the recovery began in 2009, that is a big enough drag to make it feel like another sluggish year.
It was always clear that the payroll tax holiday would have to disappear eventually; keeping it on would endanger the finances of the Social Security system. But the fact that it is disappearing at a time unemployment is still very high, growth is slow, and no other policies such as new infrastructure investment were implemented to try to offset the effects could mean that payday isn’t a fun day for American workers.