Tags: payroll | tax | cut | economy

Study: End of Payroll Tax Cut Hurt Economy More than Expected

Wednesday, 30 Jan 2013 12:25 PM

By Michael Kling

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New research shows that workers spent more of the payroll tax cut than expected — even more then they had planned to — thereby boosting the economy more than thought.

The bad news is that absence of the tax cut may hurt the economy more than expected.

Experts often debate if a lump sum, one-time tax rebate or small tax cuts spread out over time prompt workers to spend more and therefore stimulate the economy more.

Editor's Note: This Wasn’t an Accident — Experts Testify on Financial Meltdown

The study by economists at the Federal Reserve Bank of New York found that tax cuts spread over time lead consumers to spend more — even more than they want to.

The 2011 payroll tax cut that reduced the withholding rate for Social Security and Medicare from 6.2 percent to 4.2 percent for about 155 million workers ended in January.

While workers intended to spend 10 to 18 percent of their tax-cut income, they reported actually spending 28 to 43 percent of the funds, the research showed. Only 12 percent planned to spend it, but 35 percent ended up spending most of it.

Why the difference between intentions and actions?

The researchers point to what they call "mental accounting." When ask what they would to with the extra income in early 2011, workers viewed the additional income as single large amount. But they received it in relatively small amounts in every paycheck, so came to view it as extra income.

The end of the payroll tax cut may be a major reason for the sudden drop in the consumer confidence in January, which fell to its lowest level since November 2011.

The study shows that tax cuts like the payroll tax holiday have more impact than previously thought, notes Howard Gleckman of the Urban-Brookings Tax Policy Center.

"Even the authors seem somewhat baffled about why people consumed so much," he writes for the center. "Much economic theory argues they should have saved or used it to pay down debt."

Editor's Note:
This Wasn’t an Accident — Experts Testify on Financial Meltdown

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