As the first paychecks of the year roll in, more Americans are finding themselves a little poorer thanks to the expiration of the payroll tax cut which is cutting an additional 2% off of their income.
A 2% cut to the payroll tax has expired, bringing the rate back to the default of 6.2%. Combined together with the House GOP's recent concession to end the Bush tax cuts on households making more than $450,000, the tax hikes are expected to slow economic growth by a combined 1% this year and reduce household incomes by a combined $125 billion — according to mainstream economists.
While some of that spending decrease will not directly impact the economy in the short term, going instead to savings, a full 40% of American workers live paycheck to paycheck and will see a direct hit to their household budgets.
"The headwind to growth should be noticeable," said Michael Feroli, an economist at JPMorgan in New York City.
The decision to let the payroll tax cut expire, as well as the federal government's decision to increase the pace which it tackles the deficit, are already having noticeable effects across the country. The Tax Policy center claims the average family will see a roughly $700 a year tax increase.
Warren, Rhode Island resident Ben DeCastro, who works at a marketing manager at a chain of furniture stores, says the payroll tax increase will cost him roughly $30 a week.
"…that's $30 I'm not going to spend at a restaurant," said DeCastro, who thinks that people hit by higher taxes might spend less.
As BusinessWeek notes, the tax increase stings on other levels, too. In 2013, the payroll tax level cuts off at $113,700 – meaning that a person who makes $1 million and a person who makes $2 million pay the same rate of $7,049, making it one of the federal government's most regressive taxes.
The reduction in the rate was always intended to be temporary. But with the economy still on shaky ground, some question the wisdom of raising it now, especially since the burden will fall mostly on lower and middle income households – those most vulnerable in the recession, and those who can most actively prop up the economy by increasing spending.
Economists worry that the contractionary effect of the payroll tax hike will stack with a failure to stave off spending cuts beginning in March, by which time Congress may have agreed to large-scale cuts in government spending. The United States may finally be adopting austerity policies — but many economists say the deficit is a long-run problem superseded by the need to pull down 7.8% unemployment and increase consumer spending – most vigorously the New York Time's Paul Krugman, who claimed on Thursday that the deficit problem is "mostly solved" thanks to recent agreements on spending cuts and tax hikes (including the payroll tax adjustment).
"While you weren't looking, and the deficit scolds were doing their scolding, the deficit problem (such as it was) was being mostly solved. Can we now start talking about unemployment?" Krugman asked.