Don't be fooled by the enthusiastic headlines and stock market gains that have resulted from Washington's step back from the "fiscal cliff." Average working stiffs throughout the United States are still about to take a direct and almost immediate $100-billion-a-year tumble – and the economy will bear the bruises.
Democratic and Republican negotiators concluded early in the budget-deal negotiations that both sides were willing to sacrifice one major set-to-expire tax break that had been putting money directly in the pocket of every working American for the past two years: the Social Security payroll tax holiday. This had reduced the tax deducted from employees' paycheques to fund the national Social Security program to 4.2 per cent from 6.2 per cent; for the average American wage earner, the holiday equated to roughly $1,000 more a year in take-home pay.
Now it's gone. Poof. No provisions were made in the "fiscal cliff" deal to extend it, so the tax reverts to its previous 6.2 per cent. Starting with the first paycheque of 2013, U.S. workers will see their take-home pay shrink, roughly to the tune of a tank of gasoline, each and every biweekly payday. Unlike many of the other expiring tax breaks and spending cuts, there's no easing into this one as the year progresses; consumers are being shoved over the edge just as the Christmas bills come rolling in.
The estimated annual cost of the payroll tax break is in the neighbourhood of $100-billion (U.S.). Since Washington has been making up the difference in Social Security contributions during the tax holiday, the expiration of the tax break effectively shifts this burden off the government deficit and directly on to wage earners.
For all the talk of the budget deal taxing the rich and sparing the middle class, the payroll tax increase does just the opposite. Not only do many of the richest U.S. taxpayers derive considerable income from non-payroll sources that aren't subject to the payroll tax (investment income, for instance), their exposure to the payroll tax is capped on the fat paycheques they do collect. Any income above $113,700 is exempt from the payroll tax in 2013. As Forbes.com contributing writer Igor Greenwald said recently, average Joe earners will bear the brunt of the tax increase, "while $400,000-a-year lawyers will be out less than 1 per cent of their paycheque."
If you wanted to cook up a broad-based consumer-led economic slowdown, this would be a pretty good recipe for it. Economists at JP Morgan recently estimated that the expiration of the payroll tax holiday would cause a 0.6-per-cent drag on U.S. economic growth in 2013.
Pierre Lapointe, head of global strategy and research at Pavilion Global Markets Ltd., noted that the end of the tax holiday will hurt consumer debt, too. He cited a Federal Reserve Board survey that showed that one-third of U.S. workers had used their payroll tax reduction to pay down debt.
"If the payroll tax holiday was indeed helping to accelerate the deleveraging process, then we can assume its expiration will slow households' return to credit demand and consumption growth, two major pillars of the U.S. economy that need to return before we can expect sustained economic growth," he concluded.