Tax reductions Archives - Colorado-based Business and Economic Research

The recent tax cut package passed by Congress is expected to raise real GDP by .6 to 1.2% points depending on the economist making the projections. As a result, projected Real GDP growth for the nation is expected to be in the range of 2.3% to 4.0%.

The lion’s share of the benefit lies in the short-term reduction of the Social Security payroll tax rate paid by
employees. For 12 months, that percentage will be reduced from 6.2% to 4.2%.

This is often referred to as the FICA tax holiday. The federal government does not actually make payments, they simply collect less revenue.

The following is a back-of-the napkin look at the impact of this part of the tax holiday on Colorado:

Let’s start with the following assumptions:
• Colorado has a covered workforce of 2.2 million people.
• Total covered wages are approximately 100 billion.
• About 85% of the workforce (private sector + federal employees) pay FICA taxes.

From these assumptions we can derive the following:
• About 1.87 million workers will benefit from the tax cut (2.2 million *.85).
• The total wages impacted will be $85 billion ($100 billion total state wages *.85)
• The “cost” of the program to the federal government for stimulus in Colorado, or the maximum amount of
stimulus for Colorado is $1.7 billion ($85 billion *.02)
• Each worker will receive about $900 per year, or $75 per month ($1.7 billion/1.87 million workers).

To calculate the impact to the state it is necessary to make another set of assumptions.
• Because payments are disbursed over a period of a year, rather than in a lump sum; it will be assumed that
slightly less than 1/3 will be invested, saved, or used to reduce debt.
• Slightly more than 1/3 will be used to purchase services (doctors, dentists, massages, etc.).
• Slightly more than 1/3 will be used for retail purchases.
• The Colorado sales tax rate is 2.9%.
• Because Colorado is a home rule state, sales tax rates for cities and districts vary based on location. For
ease in computation it will be assumed that the average rate of combined municipal and district sales taxes is 5.1%.

From this set of assumptions the final set of calculations show the following:
• $500 million will be invested, saved, or used to pay down debt (this will benefit the consumer).
• $600 million will be used to purchase services (sales taxes are not paid on these expenditures).
• $600 million will be used to purchase retail goods (sales taxes will be paid on these expenditures).
• The state will receive $17.4 million in additional sales tax revenue ($600 million * .029).
• The municipalities and special districts will receive about $30.6 million in additional sales tax revenue
($600 *.051).

Let’s put this $1.2 billion “investment in the Colorado economy” in perspective.
• The 2009 Real GDP for Colorado was about $252.7 billion. The $1.2 billion infusion of money into the
Colorado economy is approximately .5% of the 2009 Real GDP. Total costs of the program (to the federal government) are almost $1.87 billion.
• The state is facing a shortfall of about $1 billion. The tax holiday will generate about $17 million.

While these efforts to jump start the economy will provide some assistance in the short-term, there will be a
significant long-term cost to the federal government for the program. Will this effort to stimulate the economy
result in sustained economic growth or will it simply be a variation on past themes and only have a short term impact? 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.

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.

Tag: Tax reductions

Impact of Tax Reduction Package (Tax Holiday) on Colorado