Congress recently passed a tax cut package designed to stimulate consumption. Most economists believe it will have a positive impact on the economy. In the case of the Conference Board, they recently raised their forecast for 2011 Real GDP growth from 1.7% to 2.3% based on the projected impact of this tax package. At the other end up the spectrum, economists foresee an impact greater than 1.0% points which will push output growth above 3.5%.
The most significant portion of the package is the reduction in the Social Security payroll tax rate paid by employees. For 12 months, that percentage will be reduced from 6.2% to 4.2%.
The following is a quick-and-dirty look at the cost of this part of the program:
1. Approximately 89% of US covered employees pay social security taxes (130 million workers * 89% = 115.7 million workers).
2. Total covered wages for the workers who pay social security taxes is $5,566.3 billion.
3. The total amount of the reduction in taxes, or payment of benefits, is $111.3 billion (2% *$5.6 trillion).
4. Nationally this equates to a reduction of about $960 per worker per year or an average monthly benefit of about $80.
Previous tax stimulus programs disbursed payments in lump sums. As a result, recipients often used this distribution of funds to reduce debt or invest in savings.
Several factors will likely cause consumers to actually spend more of the current tax cuts. Because the monthly tax payments are spread over a year, the amount received each month is relatively small, approximately $80. Consumers will find it easier to justify spending this amount because the economy is in an expansion mode. In addition the equity markets have risen over the past year, which will give consumers the feeling that they are wealthier. In many cases, consumers have reduced their debt loads and boosted their savings, which will also makes it easier to rationalize spending all or most of the money received rather than saving it.
Given this rationale, it can be assumed that consumers will use 25%, or an average of $20 per person per month, of their tax reduction to increase savings or pay off debt. In other words, consumers will invest just under $28 billion to pay down debt or increase savings.
Likewise, they will spend approximately $83 billion to purchase goods or services. The portion that is used to purchase retail goods will also benefit some state and local governments through the collection of retail sales taxes. As mentioned earlier, the cost of the program is $111 billion and the payback through increased purchases is $83 billion. Time will tell whether this is a good investment.
Will employers treat this windfall to employees as a de facto pay increase and refrain from granting pay increases in a market that already favors the employer? Will this fiscal stimulus foster sustained economic growth or will it only have a short term impact on growth? How will this stimulus effort shape the discussion for the upcoming 2012 elections?
These and other questions will be answered over the next 18 months, when we can look back and see if this effort to bolster the economy really was a difference maker.
©Copyright 2011 by CBER.