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JPMorgan: If the payroll tax cut falls, so does growth

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A few months ago, JPMorgan thought there was a chance that the payroll tax holiday would be extended as part of a fiscal cliff deal. Now it doesn't think the tax cut stands a chance of surviving—to the serious detriment of the economy next year.

"We are no longer of the belief that the payroll tax holiday will be extended. That change alone is worth over half a percent on GDP growth next year," JPMorgan's economic research team writes in a new research note. It's downgraded its GDP growth forecast for the first quarter from 1.5 percent to just 1 percent and revised its second quarter forecast from 2.25 percent to 1.5 percent.

Why? JPMorgan estimates that the payroll tax hike "will reduce U.S. disposable income by $125 billion," depressing consumer spending and causing a significant contraction in the economy.

Opponents of another payroll tax extension have stressed the need to shore up the finances of the Social Security Trust Fund, which the tax supports, and cite economic literature suggesting that consumers wouldn't be likely to spent very much of a temporary tax break, instead saving it or using it to pay down their debt.

But JPMorgan believes that another payroll tax extension in 2013 would actually have a bigger immediate impact on the economy that will be lost if it's allowed to expire:

There are some reasons to think the spending multiplier for the payroll tax cut may be larger than that for the 2008 onetime payments. First, because of the weak economy and still tight consumer credit conditions, more households may be “liquidity constrained,” i.e., would like to spend more if only they could access saved or borrowed funds. This may be particularly true since the payroll tax cut is proportionally more important for lower- and middle-income households, precisely those more likely to be liquidity constrained. For these households, the entirety of any tax windfall is likely to be spent.

In total, that end of the payroll tax holiday will reduce consumer spending "by close to $100 billion, or about 0.6 percent of GDP," the firm concludes. Even if that impact is spread out over many months, it adds, "the headwind to growth should be noticeable."