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Will 2013 Tax Hikes Slash Consumption?

 January 15, 2013 09:55 AM

The just enacted "American Taxpayer Relief Act of 2012" effectively averted most tax hike components of the feared fiscal cliff. Nevertheless, there still are increases in household taxation equivalent to around 1 percent of GDP.

This is because, two-thirds of that represents termination of the temporary two-year cut in Social Security payroll contributions and the other third is from higher Federal income taxes for higher-income taxpayers.

"However, we believe that the recently legislated higher household sector taxes in 2013 considerably overstate the related negative consumption impacts," UBS economist Maury Harris wrote in a note to clients.

The negative consumption impact from the Social Security payroll tax rise should be far less than the estimated $115 billion hike in such taxes this year. That is because the temporary two percentage point Social Security tax rate cut in 2011-2012 was not a big consumption booster.

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According to survey data processed by economists at the Federal Reserve Bank of New York, only around 40 cents of each $1 payroll tax cut in 2011 ended up in consumption. The rest went toward reducing debt and more saving.

"Such a finding is consistent with the familiar behavioral hypothesis that consumption depends more on perceived permanent income instead of just temporary disposable income changes stemming, for example, from a publicized only temporary tax rate change," Harris said.

Higher Federal income taxes on relatively wealthy taxpayers should be accompanied by a drop in savings that limits the negative near-term consumer spending impact.

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"Saving rates increase sharply at higher income levels, with the saving rate estimated at 51 cents on the dollar for the top 1% of the income distribution and 37 cents on the dollar for the top 5%," Harris noted .

The higher top marginal tax rate apparently is limited to incomes within the top 1 percent, with the phase out of personal exemptions and itemized deductions limited to just the top few percent of the income distribution.

Higher marginal tax rates will impact taxpayers with over approximately $1/2 million in adjusted gross income before deductions. Around 69 percent of such incomes are earned by high-saving taxpayers making over $1 million per year. The limits on deductions will affect taxpayers with over approximately $1/3 million in adjusted gross income.

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