Study: Consumers spent more of payroll tax cut than intended

By Bernie Becker - 01/29/13 02:18 PM ET

Workers in the United States, who saw a rise in their paychecks from the recently ended payroll tax holiday, spent more of that tax cut than they planned to, new government research shows.

A new report from the Federal Reserve Bank of New York found that workers surveyed in late 2011 said that they had, on average, spent 36 percent of their tax cut.

But a survey conducted earlier that year, around the time the payroll tax holiday went into effect, found that workers expected to spend around 14 percent of their extra funds.

Grant Graziani, Wilbert van der Klaauw and Basit Zafar, the authors of the New York Fed study, acknowledged that their findings didn’t dovetail with other economic estimates about the payroll tax cut, which was enacted to spur demand consumer spending.

But the three authors suggested that doling out the tax cut in smaller, regular chunks might have increased the amount of stimulus it provided.

“This would suggest that perhaps, as policy-makers had originally hypothesized when determining the design of the tax cut, the mechanism through which the tax cut was implemented – as a change in the withholding rate instead of a one-time lump-sum rebate – led consumers to spend a greater proportion of the extra income,” the New York Fed study said.

The two-percentage point cut in the payroll tax was enacted in late 2010, as part of the broad deal that extended all Bush-era rates for two years, and was originally scheduled to be in effect for just one year.

But with the economic recovery still scuffling in late 2011, Democrats pushed hard to extend the tax cut for 2012 as well. Taxpayers paid as much as $2,200 less a year under the payroll tax cut, with a worker making $50,000 annually getting a $1,000 cut.

The tax cut was not extended for a third year in the recent fiscal-cliff deal, with some Democrats concerned about the tax cut’s impact on Social Security and some Republicans saying they did not believe the holiday sparked more economic growth.

Some economic analysts have predicted ending the holiday would be a drag on economic growth in early 2013.

Howard Gleckman of the Urban-Brookings Tax Policy Center, also noted that the study found that higher-income workers were more likely to spend their tax cut, the opposite of what analysts projected.

“If these results turn out to be correct, they suggest that payroll tax cuts may do a better job stimulating demand than many economists think,” Gleckman wrote.