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Gail MarksJarvis: Retail sales report could hint whether higher payroll tax is hurting recovery

January retail sales figures on Wednesday will be first peek at shoppers' reaction

Gail MarksJarvis

February 13, 2013

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Could the federal government's belt-tightening become a noose around consumer spending?

As political leaders debate Round 2 of government debt-cutting, investors will be keenly focused Wednesday on the release of the Commerce Department's retail sales numbers for January.

The sales figures are the first piece of data that will hint at whether consumers became reluctant shoppers when they noticed their paychecks slimmed down by a federal payroll tax increase that started in January. The tax jumped 2 percentage points, to 6.2 percent of pay, or roughly $1,000 a year for a household earning $50,000.

"The retail sales report is eagerly anticipated," said Capital Economics economist Paul Dales, who forecasts a 0.3 percent monthly decline in total retail sales amid cautious spending.

Consumer behavior is important because about two-thirds of the economy depends on it. And analysts have been tinkering with expectations for the economy as more rounds of government cuts and tax increases are envisioned. With the economy growing recently at less than 2 percent and consumers using credit cards sparingly as they continue to dig out of debt, shrinking paychecks could hurt.

The Federal Insurance Contributions Act, or FICA, tax increase that began in January was the part of the "fiscal cliff" package that hit taxpayers of all income levels. It probably took many Americans by surprise because much of the chatter focused on whether the rich should be taxed more.

On the surface, the payroll tax increase appears small, and it's not a new tax. It simply reinstates FICA taxes that were eliminated temporarily a couple of years ago to make it easier for individuals to survive the recession. The tax money goes toward funding Social Security.

Although the cut was never intended to be permanent, people get accustomed to their take-home pay and adapt their spending accordingly. So any reductions in take-home pay can be a shock that prompts people to think twice about making purchases. That's especially true of moderate-income taxpayers.

"Among the most important questions confronting investors is whether the January tax increase will derail or merely decelerate the weak U.S. recovery," said Michael Gavin, who heads asset allocation research for Barclays Capital.

He doesn't expect one month of data to tell the story, but he thinks it could hint at what may happen as later government cuts or tax increases are imposed. On March 1, the automatic cuts set in motion by Congress in August 2011 are expected to take hold, with about $85 billion in cuts this fiscal year — half in defense and half in non-defense spending.

Gavin doesn't think the payroll tax alone will derail the economy. Like many economists, he expects it to grow slowly in the first half of the year, while spending cuts and tax increases erode some consumer and business spending. But economists generally expect stronger growth after midyear.

Barclays economists expect sluggish growth, of 1.5 percent, in the first quarter, 2 percent in the second and 2.5 percent in the second half of 2013 and into 2014. Goldman Sachs has a similar view of the short term and expects 3.5 percent in the course of 2014.

If Wednesday's retail numbers suggest that "households appear to be powering through the tax hike with a modest deceleration of growth in spending, then it will be very reasonable for investors to conclude that the broader economy will do the same," Gavin said.

"Even a modest gain in retail sales should be viewed as impressive, given the 0.9 percent hit to disposable income from the payroll tax hike," said Jim O'Sullivan, economist for High Frequency Economics. And investors are likely to see any strength in retail sales that way. O'Sullivan is forecasting a 0.3 percent rise in total sales. While taxes could be a drag on consumer spending, he thinks "a pickup in wage income" is helping.

Retailers have been reporting stronger-than-expected sales. On Tuesday, stocks of companies that depend on discretionary consumer spending rose after both Fossil and Michael Kors reported better-than-expected earnings.

Still, economists suggest that Wednesday's retail numbers may not adequately reflect the consumer's pulse. JPMorgan Chase economist David Hensley notes that some taxpayers probably haven't felt their tax increase yet because companies aren't required to institute it until Feb. 15. Those that have delayed will have to make up for undercollection of taxes by March 31 — another potential shock to unsuspecting employees.

In addition, there is sometimes a delay in behavior after tax increases.

"The consumer seems to be holding up well so far," despite a $200 billion increase in the FICA taxes and taxes for affluent taxpayers, said Goldman Sachs economist Jan Hatzius. He notes that January light-vehicle sales held up well, at about 15.2 million.

Goldman economists said in a report that they share the "glass-half-full view" of the economy that dominates the financial markets as stocks approach 2007 peak levels. They said the data is "not too bad in a month that saw the biggest tax increase in several decades."

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis