The Union Recorder

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January 11, 2013

Here's why your paycheck just shrank

(Continued)

WASHINGTON —

But the open question for the economy in 2013 is whether Americans adjust differently when their paychecks have a tax-induced decline than they did when they received a bump.

In terms of consumer psychology, behavioral economists speak of "loss aversion," a tendency of people to be much more bummed out when they think they have lost something that belonged to them than if they gain it. A child might be much more upset to have a cookie taken away from them than they are happy to be given a cookie.

It is possible that as Americans learn of their lower take-home pay — either from reading news accounts around the fiscal cliff deal last week, or from opening their first paycheck of the year — they will adjust their entire spending plans for the year, which could make January a rough month for retailers and the economy as a whole.

In a new analysis, Goldman Sachs economists ran a number of different economic models to assess the impact of higher taxes from the fiscal cliff deal on the economy in 2013 (the payroll tax is the biggest, but they also included higher income tax rates on households making over $450,000 and some smaller tax provisions that reduce deductions for those making over $250,000). Those different models — Goldman's in-house macroeconomic model, one used by the Federal Reserve, and analysis drawn from work by economists Christina and David Romer examining how consumption patterns have adjusted in the past to changes in tax policy — all find a hit to growth of around one percentage point in the first half of the year. Given that growth has been bouncing around at about 2 percent since the recovery began in 2009, that is a big enough drag to make it feel like another sluggish year.

It was always clear that the payroll tax holiday would have to disappear eventually; keeping it on would endanger the finances of the Social Security system. But the fact that it is disappearing at a time unemployment is still very high, growth is slow, and no other policies such as new infrastructure investment were implemented to try to offset the effects could mean that payday isn't a fun day for American workers.

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