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Higher food and energy prices take a bite out of tax cuts

By Ylan Q. Mui
Washington Post Staff Writer
Monday, February 28, 2011; 11:51 PM

Rising food and energy prices ate away at the extra money workers received in January from a reduction in the payroll tax, according to government data released Monday, stalling the momentum in consumer spending.

The Obama administration had hoped to prop up the country's economic recovery through a wide-ranging tax-cut package passed late last year. One of the key components of the program is a 2 percent cut in the amount that workers must pay toward Social Security in 2011 - which the White House had hoped would encourage consumers to spend more.

The tax cut saved workers roughly $66.3 billion and helped boost incomes by 1 percent in January compared with the previous month, the government data show. But much of the increase went toward paying for more expensive food and fuel, which together account for about one-fifth of consumer spending, the Commerce Department report said.

Energy prices jumped 2.3 percent in January compared with the previous month, and food costs rose 0.7 percent. When adjusted for price inflation, consumer spending dipped 0.1 percent.

"It seems like events seem to have a way of conspiring to ensure that temporary tax cuts are no help to the economy," said Mark Vitner, a senior economist at Wells Fargo. "Higher food and energy prices look almost certain to take away any lift."

One of the factors that pushed up the price of fuel in January was the improving global economy. As factories produced more goods, and trucks and planes shipped them around the world, demand for oil boosted prices. The cost of a gallon of gas inched up three cents in January to an average of $3.10.

Consumers' wallets took an even bigger hit in February as civil unrest flared throughout the oil-rich Middle East, sending gas prices even higher. Over the past month, fuel prices jumped nearly 3 percent to an average of $3.19 per gallon, government data show.

A confluence of extreme weather and rising demand from emerging markets such as China have helped drive up global food prices in recent months to the highest levels since 2008. The World Bank said the runup in food prices was dangerous and was contributing to the turmoil in the Middle East and elsewhere. Although the impact in the United States has been muted in comparison, several manufacturers have said they will have to pass the price increases on to consumers.

As a result, economists said, the country is unlikely to sustain the robust economic growth enjoyed at the end of last year. Economist Chris Christopher, of IHS Global Insight, said he expects consumer spending to rise 2 to 3 percent during the first quarter, compared with 4.4 percent growth last quarter.

"The uncertainty has increased, and our outlook for consumer spending has been bumped down a little," he said.

How significant of a stumbling block energy prices will be depends on how long they stay high, said William Stone, chief investment strategist at PNC Wealth Management. A study by the Federal Reserve found that a $10 rise in the price of a barrel of oil typically dampens growth by 0.2 percent. But Stone said that research was based on a sustained price increase, and it remains to be seen whether the recent spikes will turn into long-term hikes.

In the meantime, consumers are sitting on their pocketbooks. The personal savings rate rose from 5.4 percent in December to 5.8 percent in January, though Vitner cautioned that some of the increase was a technical result of the payroll tax cut. Still, paying more at the pump is likely to deter consumers from making more discretionary purchases, even if they have the money to spend.

"The perception of inflation is actually worse than the reality," he said.

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