Will the Payroll Tax Increase Affect Retail Sales?

TaxesThe ICSC-Goldman Retail Chain Stores Index fell 1 percent week-over-week for the seven-day period ended January 26, the fourth consecutive period of declines. Year over year, store sales grew 2 percent, 1.2 points shy of the 3.2 percent growth rate trend that was established heading into the reading. Similarly, the Redbook report shows year-over-year retail growth of just 1.6 percent for the week ended January 26, compared to 1.8 percent average growth for December.

Consumer spending accounts for as much as 70 percent of economic activity, and patterns of consumer behavior are like economic trade winds that investors can use to plot a course through the markets. Strong consumer spending generally translates into strong economic growth, but this week’s underwhelming reading indicates that a recovery is still brewing. Consumers could be fatigued from holiday shopping and adding to savings instead of spending. Financial belts are still tight and average wages aren’t growing very quickly, further catalyzing saving behavior.

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Michael Niemira, ICSC chief economist, offers one contributing factor, commenting that “temperatures were sharply colder this past week than last year, which may have helped the clearance of seasonal apparel, but it also seemingly held back the consumers spending in most segments.” However, more likely to blame is the expiration of the two-year payroll tax holiday…

taxmanThere’s not a lot of data to go on three weeks into the year, but many observers have already indicated that the expiration of the payroll tax holiday will have a material effect on consumer spending. Now at its 2010 rate of 6.2 percent, the payroll tax hike is expected to curb first-quarter economic growth by a full percent, and pull 0.6 percent off of the full-year GDP.

The idea here is that while the government will always spend the money it earns, it won’t necessarily spend it well. The same amount of money in the hands of market participants could be put to better use. The tax affects an estimated 160 million Americans who will see hundreds or thousands of dollars evaporate from their annual take-home pay.

The short answer is: yes, the payroll tax increase is likely to affect consumer spending. Less money in the pocket of a consumer is less money that can be spent. Unemployment is still high and budgets are still tight. A few hundred bucks spread across 160 million Americans can go a long way, and without that spending money, retail sales are likely to suffer.

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