When Congress approved sweeping tax cuts last year in hopes of giving the economy an extra boost, it might not have anticipated how much oil and food prices would weigh on consumers.
Is $4 gasoline around the corner?
Consumer spending, which makes up about 70% of the U.S. economy, cooled in January. It rose by 0.4% after a modestly bigger 0.7% gain during the previous month, the Commerce Department reported this week. This comes even as many workers saw a bump in their paychecks as the new Social Security tax break approved in December took effect, helping to boost personal income by 0.4% and disposable income by 0.7%.
But for better or worse, that extra income isn't translating into extra spending for many workers. The personal savings rate edged up to 5.8% in January, reversing its steady fall from a 6.3% high last June.
It might be too early to say why exactly consumer spending has slowed. Perhaps, as Daniel Indiviglio of the Atlantic pointed out, they took a break after all the holiday shopping. Or maybe, as some economists suggest, winter storms kept more people home and away from stores.
But it's also possible that factors like rising commodity prices and consumers' desire to save more are overriding the extra spending that Congress had hoped for with the passage of the tax cuts.
Though crude oil has fallen some this week, prices briefly touched the psychologically significant $100 a barrel mark in New York last week. The commodity gained 5.2% last month and is 24% higher than a year ago, translating to higher prices at the pump. With unrest in the Middle East and North Africa, gasoline prices have been on a steady climb for the past seven days, reaching a new national average of $3.38 per gallon, up from $3.17 last month.
What's more, global prices for everything from corn, wheat and soybeans have been trending up, rising in January for the seventh month in a row, according to the U.N. Food and Agriculture Organization. Its monthly food price index rose to 231 points, up 3.4% from December 2010 and the highest level since the index has been backtracked in 1990.
Food inflation is expected to surge in the second half of this year as wholesale prices filter through the supply chain, impacting consumers even more in the grocery aisles.
Despite the boost to incomes, it's clear higher prices have started putting a dent on consumption. Nominal spending (which is adjusted for inflation) rose by just 0.2% in January over the previous month, but real spending (which does not adjust for inflation) fell by 0.1% during the same period -- the first drop in a year, according to Capital Economics senior economist Paul Dales.
Dales sees this as a sign that higher gasoline and food prices have already started putting downward pressure on real consumption. Severe snowstorms in January, he adds, probably pulled back spending as well. Consumption will likely bounce back in February and possibly also in March. But while consumption is likely to be relatively strong during the first half of the year, higher prices at the pumps and in grocery stores will probably thwart the attempt by Washington policymakers to try and stimulate the economy.
"The way things are going at the moment, all the payroll tax cut will do is offset the rise in gasoline and food prices, rather than provide a boost to real spending." Dales says.
It remains to be seen how consumers will respond in the coming months. Workers might start noticing that they're taking home more pay and therefore save less. But even then, higher prices might just keep them from anything much beyond basic necessities.
Also on Fortune.com:
The article's title about the "payroll tax cut (not) working" is silly. A far more accurate headline would be "No measurable effects yet". People's spending behavior doesn't turn off and on like a switch based on the latest Government policy. I'll bet most of us haven't even realized there was a change in tax rates yet.
Three reasons that there is no significant change in consumption (and the article included some of the reasons but missed the big one): 1. Too soon to make an impact in behavior, especially as people are still catching up from the last few lean years. 2. Too small of a rate cut to really change behavior, and most of the pay increase was immediately eaten up by inflation
But, the BIG reason for lack of increased consumption: 3. Most consumers and business-owners have no confidence that Government is going to fix the massive overspending problem. Couple that with uncertainty in World Affairs and you have the answer as to why many of us will not loosen our purse strings. We are apprehensive about the future and feel it is irresponsible to spend heavily now. T
While the data in the article seems well-researched, data alone doesn't tell the story. Sometimes living in NYC with a Graduate Degree makes it hard for columnists to see the economic forest for the trees.
Bill: There is a Making Work Pay tax credit this year. Same as last year.
The other thing to remember is, all those people with incomes under 20,000 per year had tax increases. That's because the Making Work Pay tax credit that expired for each working individual was $400. So anyone making under $20K per year had a tax increase when the the 2% payroll tax replaced the Making Work Pay Tax credit.
CUT??!! CUT??!! What Sweeping Tax cuts? The "Cuts" this article is refering to is the EXTENTION of the Bush tax cuts from 2001 and 2003. The only tax that was cut was the SS tax at a measily bit. Why in the world you anticipate an increase in consumer spending if tax rates are held steady at the current rates? If the government wants to get serious they need to end the capital gains taxes and lower corporate taxes so that the labor market tightens up and raises competition for workers. Thats how you get incomes to rise across the board.
Reading these comments reminds me why it's so hard to ever arrive at reasonable fiscal policy in this country. People, naturally, look at things from how it impacts them personally. I still assert that the payroll tax cut was dumb because it further underfunds an already underfunded system.
Coincidentally, we got a 2% tax increase in Illinois for this year, therefore, that offset the federal reduction, and with the prices coming up, that makes it more difficult for people in the state to increase the spending.
"The way things are going at the moment, all the payroll tax cut will do is offset the rise in gasoline and food prices, rather than provide a boost to real spending." Dales says.
Can you imagine what would have happened if the payroll tax cut was not given to us?
Well you wouldn't need a crystal ball to see this coming. My company immediatly took advantage of the increase. Since they missed their forcasted numbers they "took" exactly that amount from our pay, thus giving us a paycut that amounted to the same as the increase. Which now they claim everyone from the Pres down will have to endure, but what they don't say is that while he's taking a cut in pay just as us. They will all gain their $15 Million bonus, which is far better than taking a 2% cut in pay. By the way this company is Computer Science Corp. Thanks for the hit Joe S.
Could also be the higher Health Care costs, my paycheck went up by a measly $4 after, with the cuts to SS being wiped out by higher health care costs. Many people I know saw an overall drop in their paycheck.
I can say why my spending has not gone up - because the tax cut was trumped by a doubling of my company sponsored medical insurance. I'm actually taking home less than last year
Or we could say it has unintended consequences ... like taking the edge off of inflation in food and fuel, rather than its intended stimulus. Keeping a bad situation from getting worse, rather than making a bad situation better.
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